Key Takeaways
- Measures long-term debt proportion of total assets.
- Low ratio signals stronger solvency and lower risk.
- High ratio indicates heavy debt and higher risk.
What is Long-Term Debt to Total Assets Ratio?
The Long-Term Debt to Total Assets Ratio measures the proportion of a company's total assets financed through long-term debt, calculated as long-term debt divided by total assets. This key obligation metric helps assess a firm's leverage and solvency by focusing on debts due beyond one year relative to all owned resources.
This ratio is widely used by investors and creditors to evaluate financial stability, especially in C corporations and other entities with significant capital structures.
Key Characteristics
This ratio highlights how much of your assets are funded by long-term borrowing:
- Long-Term Debt: Includes bonds, loans, and other debts with maturities over one year.
- Total Assets: Combines current assets like cash and inventory with fixed assets such as property and equipment.
- Leverage Indicator: A higher ratio signals greater financial risk and dependence on debt financing.
- Industry Variance: Capital-intensive sectors tolerate higher ratios than tech or service industries.
- Balance Sheet Focus: Derived directly from financial statements, providing a snapshot of financial structure.
How It Works
To calculate the ratio, divide the total long-term debt by the total assets reported on the balance sheet. For example, if a company reports $50 million in long-term debt and $200 million in total assets, the ratio is 0.25, meaning 25% of assets are debt-financed.
This metric helps you understand the company’s capital structure and risk profile, as long-term debt must be serviced over multiple years, affecting cash flow and solvency. It complements other financial measures such as interest coverage ratios and liquidity metrics, providing a fuller picture of financial health.
Examples and Use Cases
Here are typical scenarios where the ratio is particularly informative:
- Airlines: Delta often carries high long-term debt due to expensive aircraft purchases, reflecting in a higher ratio typical for the industry.
- Banking Sector: Banks featured in best bank stocks reports usually maintain moderate ratios to balance growth and regulatory capital requirements.
- Large Cap Companies: Firms listed among best large cap stocks may exhibit varied ratios depending on their financing strategies and asset bases.
- Bond Investors: Those focused on best bond ETFs analyze this ratio to assess issuer credit risk and the sustainability of debt levels.
Important Considerations
When using the Long-Term Debt to Total Assets Ratio, consider industry benchmarks and the company’s ability to generate cash flow to service debt. A high ratio isn't always negative if the company maintains strong profitability and operational efficiency.
Also, be aware that this ratio excludes short-term liabilities and does not reflect the quality or liquidity of assets. Combining this ratio with other financial indicators provides a more accurate risk assessment before making decisions in investments.
Final Words
A Long-Term Debt to Total Assets Ratio below 40% generally signals prudent leverage, while higher ratios warrant closer scrutiny for financial risk. Review your company's ratio against industry peers and consider consulting a financial advisor to ensure your debt levels align with your long-term stability goals.
Frequently Asked Questions
The Long-Term Debt to Total Assets Ratio measures the portion of a company's total assets that are financed through long-term debt. It is calculated by dividing long-term debt by total assets, helping assess financial leverage and solvency.
You calculate it by dividing a company's long-term debt by its total assets. For example, if a company has $20 million in long-term debt and $100 million in total assets, the ratio is 0.20 or 20%, meaning 20% of assets are funded by long-term debt.
This ratio helps investors understand how much of a company’s assets are financed through long-term debt, indicating leverage risk. A lower ratio suggests less risk and stronger solvency, while a higher ratio may signal potential liquidity problems or financial distress.
A low ratio, typically below 40%, indicates that a company uses more equity than debt to finance its assets. This conservative financing approach usually means lower financial risk and better ability to secure new debt if needed.
Not necessarily. While a high ratio above 60% signals greater leverage and potential risk, some capital-intensive industries like utilities naturally have higher ratios. It’s important to compare ratios within the same industry for accurate interpretation.
The Long-Term Debt to Total Assets Ratio uses total assets as the denominator, while the Long-Term Debt to Net Assets Ratio uses net assets (total assets minus current liabilities or equity). The latter focuses more on equity-like resources, whereas the former looks at all assets.
A ratio greater than 1 means long-term debt exceeds total assets, indicating insolvency risk. This situation suggests the company may struggle to cover its debts with its assets, posing serious financial concerns.
Comparing the ratio across companies, especially within the same industry, helps identify how much leverage each firm uses. It highlights which companies rely heavily on debt and which have a more balanced or conservative capital structure.
