# Understanding the Debt-to-Capital Ratio: Definition & Calculations

> **Definition**
>
> The debt-to-capital ratio is a financial metric that measures a company's financial leverage by dividing its total interest-bearing debt by the sum of its total debt and shareholders' equity.

## What Is the Debt-To-Capital Ratio?

The the debt-to-capital ratio is a metric used to assess financial leverage by dividing total debt by total capital. Total capital consists of both interest-bearing debt and [shareholders' equity](https://www.investopedia.com/terms/s/shareholdersequity.asp), such as common stock. This ratio comes in handy when comparing the financial health and investment risk of different companies. All else being equal, the higher the debt-to-capital ratio, the riskier the company. Bear in mind that, since most companies finance their operations through a mixture of debt and equity, looking at the total debt of a company may not provide the best or most complete information about a company's financial well-being.

### Key Takeaways

*   The debt-to-capital ratio gauges a company's financial leverage by comparing its interest-bearing debt to total capital.
*   A higher debt-to-capital ratio indicates greater financial risk as more of the company is funded by debt.
*   This ratio offers a clearer view of a company's financial health by framing debt as a percentage of total capital.
*   Unlike the debt ratio, the debt-to-capital ratio excludes non-interest-bearing liabilities.
*   Variables on financial statements may distort the ratio, so using accurate current market values is crucial.

![Debt-to-Capital Ratio](https://www.investopedia.com/thmb/AoNKVVEoCXUV3QYqVQVaZlBKpao=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TermDefinitions_Debt-to-CapitalRatio-c25b169207f64c2d8759194ba8be3aa9.jpg)

*— Investopedia / Crea Taylor*

## Calculating the Debt-To-Capital Ratio: Formula Explained

$\text{Debt-To-Capital Ratio} = \frac{Debt}{Debt \text{ }+\text{ } Shareholders'\ Equity}$

To calculate the debt-to-capital ratio, divide the company's total debt by its total capital—this includes total debt and shareholders' equity.

## Understanding Insights from the Debt-To-Capital Ratio

The debt-to-capital ratio helps analysts and investors assess a company's financial structure and investment suitability. A higher ratio indicates more debt relative to equity, signaling greater risk because of increased repayment obligations.

A debt amount that cripples one company might hardly affect another, so using total capital frames debt as a percentage, offering a clearer picture of a [company's health](https://www.investopedia.com/ask/answers/040715/what-are-some-strategies-companies-commonly-use-reduce-their-debt-capital-ratio.asp).

## Practical Example of Using the Debt-To-Capital Ratio

As an example, assume a firm has $100 million in liabilities comprised of the following:

*   Notes payable $5 million
*   Bonds payable $20 million
*   Accounts payable $10 million
*   Accrued expenses $6 million
*   Deferred income $3 million
*   Long-term liabilities $55 million
*   Other long-term liabilities $1 million

Of these, only notes payable, bonds payable, and long-term liabilities are interest-bearing securities, the sum of which total $5 million + $20 million + $55 million = $80 million.

The company's equity includes $20 million in preferred stock and $3 million in minority interest. With 10 million common shares at $20 each, total equity amounts to $223 million. Using these numbers, the calculation for the company's debt-to-capital ratio is:

*   **Debt-to-capital** = $80 million / ($80 million + $223) = $80 million / $303 million = 26.4%

If a portfolio manager compares this company to another with a 40% debt-to-capital ratio, this company, with a lower ratio, appears safer due to less [financial leverage](https://www.investopedia.com/terms/t/timevalueofmoney.asp).

As a real-life example, consider Caterpillar (NYSE: CAT), which has $36.6 billion in total debt as of December 2018. Its shareholders’ equity for the same quarter was $14 billion. Thus, its debt-to-capital ratio is 72%, or $36.6 billion / ($36.6 billion + $14 billion).

## Comparing Debt-To-Capital Ratio vs. Debt Ratio

The [debt ratio](https://www.investopedia.com/terms/d/debtratio.asp) divides total debt by total assets, showing how much of a company’s assets are financed with debt. While it can be similar because total assets equal liabilities plus equity, the debt-to-capital ratio only includes interest-bearing debt.

## Recognizing the Limitations of the Debt-To-Capital Ratio

Accounting methods can influence the debt-to-capital ratio, as financial statements often use historical costs that don't reflect current market values. It’s crucial to use accurate figures in calculations to avoid distortion.

## The Bottom Line

The debt-to-capital ratio is a key measure of a company's financial leverage. It's calculated by dividing total debt by total capital. The higher ratio, the greater the amount of debt a company has and the greater the risk for investors should the company be unable to pay what it owes. Burdens of debt differ from company to company. So a dollar figure for debt alone isn't a useful metric. When framed in relation to total capital, investors and analysts can get a more accurate picture of corporate financial health.

> **Article Sources**
>
> 1.  Caterpillar. "[10-K Annual Report 2018](https://investors.caterpillar.com/financials/sec-filings/sec-filings-details/default.aspx?FilingId=13226554)," Page 46. Accessed Aug. 19, 2020.
>     
> 2.  Caterpillar. "[10-K Annual Report 2018](https://investors.caterpillar.com/financials/sec-filings/sec-filings-details/default.aspx?FilingId=13226554)," Page 24. Accessed Aug. 19, 2020.