How to calculate debt-to-capital ratio, step by step
The debt-to-capital ratio is one division that answers one question: what share of the whole capital structure is borrowed? A business that knows the answer can see how much of its funding comes from lenders and how much from its owners. The calculation is total debt divided by total capital, where total capital is total debt plus total equity — two numbers from any business’s balance sheet, added and divided. The answer is a percent: a ratio of 40.00% means 40 cents of every capital dollar is debt, and the other 60 cents is equity.
The formula is total capital = total debt + total equity, then debt-to-capital ratio = total debt ÷ total capital. Total debt is all the money the business owes — the loans, the bonds, the credit lines and the other liabilities on the balance sheet. Total equity is what the owners have put in and what the business has kept — the share capital plus the retained earnings. Both figures come from the same balance sheet, in the same currency, on the same date, or the ratio is wrong before it starts.
The worked example, line by line. Step 1 — the total debt: $400,000. Step 2 — the total equity: $600,000. Step 3 — the total capital: $400,000 + $600,000 = $1,000,000. Step 4 — the division: $400,000.00 ÷ $1,000,000.00 = 40.00%. Step 5 — the meaning: 40 cents of every capital dollar is debt. As a decimal the same ratio is 0.4000 — the percent and the decimal are two ways of writing the same number, never the same figure: 40.00% is the share, 0.4000 is the fraction. Work it yourself in the debt-to-capital ratio calculator.
What the number means
A ratio of 40.00% means 40 cents of every capital dollar is debt and 60 cents is equity, so the owners fund more of the business than the lenders do. A lower ratio means less borrowing: the business leans on its owners, and a bad year hurts the owners first. A higher ratio means more borrowing: the lenders fund most of the business, and a bad year still leaves the interest to pay. The ratio on its own never says whether 40.00% is safe or risky — that depends on the business and its industry. A steady utility can carry a high ratio because its cash flow is steady, and a young business with lumpy income can struggle at the same ratio. What the ratio does say, plainly, is how much of the capital structure is borrowed.
What moves the debt-to-capital ratio
Two things move the ratio: the debt and the equity. Raise the total debt and the ratio rises, because a bigger share of the same capital is borrowed: with equity held at $600,000, debt of $600,000 puts the ratio at 50.00%, and debt of $900,000 puts it at 60.00% — the smallest total debt for the ratio to reach 50% is $600,000, and the smallest total debt for it to reach 60% is $900,000. Cut the debt and the ratio falls. Raise the total equity and the ratio falls, because the same debt is now a smaller share of a bigger capital base: new shares issued or profits kept in the business both push the ratio down without a dollar of debt being repaid. Cut the equity — a loss, or a dividend paid out — and the ratio rises, because the same debt is now a bigger share of a smaller capital base.
When the ratio is undefined
If the total debt and the total equity are both $0, the ratio is undefined — total capital is $0, and dividing by $0 has no answer. A business with no capital at all has no ratio to calculate, only a warning. If the total debt is $0, the ratio is 0.00% — a real figure, not undefined: nothing borrowed, nothing of the capital is debt. If the total equity is $0, the ratio is 100.00% — a real figure, not undefined: every dollar of capital is debt, and the owners have nothing in the business. A negative equity figure is possible when losses have eaten past the owners’ stake, and then the ratio climbs above 100% — the debt is bigger than the capital it sits in.
Common mistakes
The first mistake is confusing this ratio with the debt-to-equity ratio — that one divides debt by equity alone, a leverage multiple, not a share of the whole capital structure. A debt-to-equity ratio of 0.67 and a debt-to-capital ratio of 40.00% describe the same $400,000 of debt and $600,000 of equity, and mixing them up doubles the confusion. The second is using only the interest-bearing debt and leaving out the rest of what the business owes — total debt means all of it, or the ratio understates the borrowing. The third is mixing dates — the debt from one balance sheet divided by the equity from another is not a ratio at all. The fourth is forgetting that the ratio says nothing about whether the debt can be repaid — a low ratio is no good if the cash flow cannot cover the interest. Work it out in the debt-to-capital ratio calculator, and check the debt-to-equity ratio calculator and the debt-to-EBITDA ratio calculator before you decide what the borrowing means.