Calculating the Long-Term Debt to Total Capitalization Ratio

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Long-term debt is defined as an interest-bearing obligation owed for over 12 months from the date recorded on the balance sheet and can be in the form of a bank note, a mortgage, debenture, etc. It is recorded on the balance sheet along with its interest rate and date of maturity. Total capitalization is the sum of long-term debt and all other types of equity, such as common stock and preferred stock, and forms a company's capital structure.

Total capitalization is also sometimes computed as total assets less total liabilities.

The long-term debt to total capitalization ratio shows the extent to which long-term interest-bearing debt, like bonds and mortgages, are used for the firm's permanent financing, or the financial leverage of the company. On the flip side, it shows how much of the firm is financed by investor funds or equity, allowing investors to identify the amount of control utilized by a company and compare it to other companies to analyze the total risk experience of that particular company.

The companies that fund a greater portion of capital through debts are known to be riskier that those with lower finance ratios.

The debt to asset ratio, the debt to equity ratio, and the long-term debt to total capitalization ratio all measure the extent of the firm's financing with debt. 

Calculating Long-Term Debt to Total Capitalization

The calculation for long-term debt to total capitalization is as follows:

Long-term Debt/Long-term debt + Stockholder's Equity = ___%

An Example

Let's look at the capital structure of company A. They have long-term debt of $70,000 ($50,000 on their mortgage and $20,000 on equipment). They have assets of $100,000, less the $70,000 in liabilities which gives them $30,000 in stockholder equity.

Thus their long-term debt to total capitalization ratio would be $70,000 / $100,000 = .7&


As the percentage gets higher, this means that a higher proportion of debt is used for the permanent financing for the firm as opposed to investor funds (equity financing). You have to have historical data from the firm and/or industry data for comparison, however. As the proportion of debt gets higher, so does risk and the chance of bankruptcy. A decrease in the ratio would indicate that there is an increase in stockholders' equity.

If the long-term debt to capitalization ratio is greater than 1.0, it indicates that the business has more debts than capital which is a strong warning sign indicating financial weakness. Any further debt would increase the company's risk. 

A high long-term debt to capitalization ratio can also increase shareholders' return on equity because interest payments are tax deductible, but it also reduces a company's financial flexibility and increases the risk of insolvency.

 A ratio less than 1.0 indicates that the business is healthy and is not having financial difficulties, that its debt burden is within easily manageable levels.  

Business owners should monitor and ensure that the long-term debt to capitalization ratio is under control so that their debt is under control.

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