Long Term Debt Ratio

Long term debt ratio is one of the financial leverage ratios measuring the proportion of long-term debt used to finance the assets of a business. This ratio represents the position of the financial leverage the company’s take. With this ratio, analysts can estimate the capability of the corporation to meet its long-term outstanding loans.

Long term debt ratio—also known as long term debt to total assets ratio—is often calculated yearly, as most business balance sheets come out once in every fiscal year. Thus, we can calculate the year-on-year results of a company’s long-term debt ratio to determine the leverage trend.

If the ratio tends to rise as the year moves forward, it means that the business is becoming more dependent on debt. On the contrary, a descending ratio shows that the company is less reliant on debts over time.

Long Term Debt Ratio Formula

$$LTD = \dfrac{\text{Long-Term Debt}}{Total\: Assets}$$

Long-term debt is debt that are due in more than one year. Some of the examples of long-term debt include bonds and government treasuries. On the balance sheet, these kinds of debts are usually written collectively as “long-term debt” under non-current liabilities.

One important thing to note is that not all long-term liabilities are debts, although most of them are. Debts are the money an entity (an individual or corporation) borrowed that need to be paid back in the future. Apart from the principal amount, debt usually incurs interest as ‘cost’ to get loaned funds. Debt is a part of liability.

Meanwhile, liabilities are something an entity owes to another party, be it money or service/goods. Wages payable, wages that employees have earned but haven’t been paid yet, is a type of non-debt liability. As you might’ve guessed, this is a common practice.

Another example of a non-debt liability is unearned revenue, which is earnings received by a business for service that hasn’t been delivered yet. Unearned revenue is a type of liability in the form of service or goods instead of cash.

The second variable is total assets. Assets are resources owned by an entity that has economic value. By using assets, corporations expect to get benefits in the long run. Assets are reported on the balance sheet in the form of current assets (cash, inventory, accounts receivable, etc.), fixed assets (equipment, buildings, etc.), financial assets (investments), and intangible assets (goodwill, copyrights, etc.).

In general, assets are things that the company truly own (equity) as well as other things that belong to someone else (liability). Therefore, assets are equal to equity plus liabilities. As a side note, equity is also often referred to as owners’ equity or shareholders’ equity.

Long Term Debt Ratio Example

Andre wishes to invest his money. He looks at the stock market and finds that one of the companies he monitors has a total assets figure of $236 billion. Among the total assets, the portion of long-term debt is $64 billion. Both of these values can be obtained from the balance sheet of the company. Can we calculate the value of long term debt ratio based on this information?

Let’s break it down to identify the meaning and value of the different variables in this problem.

  • Long-term Debt (in billion) = 64
  • Total Assets (in billion) = 236

Now let’s use our formula and apply the values to our variables and calculate long term debt ratio:

$$LTD = \dfrac{64}{236} = 27.11%$$

In this case, the long term debt ratio would be 0.2711 or 27.11%.

From this result, we can see that among the corporation’s total assets, about 27% of them are in the form of long-term debt. Put it differently, the company has 27 cents of long-term debt per dollar in assets. To determine if this ratio is a decent number, we need to compare this result to other companies of the same type. Otherwise, we can also look at the past ratio value to see if the number is increasing, decreasing, or stagnant.

Long Term Debt Ratio Analysis

Long-term debt is closely related to the degree of a business’s solvency. Investors and creditors use long-term debt as a key component in their calculations as it is more burdening compared to the short-term debt.

The overall interest amount for short-term debts is considerably less than long-term debts. To better put it into perspective, most current liabilities are even categorized as non-interest bearing current liability (NIBCL). Meanwhile, long-term debt makes up the bigger chunk of non-current liabilities with its comparably higher interest.

A higher long-term debt ratio requires the company to have positive and steady revenue to prevent raising alarm regarding solvency. To better make a good judgment concerning a business’s ability to pay debts, we need to look at the industry standard. For instance, corporations that deal with basic needs such as electricity or gas tend to have more stable cash inflows.

Hence, having a high long-term debt ratio of 35% is not a problem as creditors believe they can pay off the debt eventually. On the other hand, the same ratio may not be safe for businesses that have unstable cash flows like social media companies since competitors may easily take the market share in the future.

With that said, long-term debt in itself is not always negative. If used wisely, it can promote the growth of a company. Companies that reluctant to take advantage of long-term debt may find themselves in a stagnant condition.

Besides, having a low long-term debt ratio does not always give companies a good reputation as that can also mean that the company is struggling to get reliable revenue. Thus, companies need to strike the balance between growth and risks to appeal to investors.

Long Term Debt Ratio Conclusion

  • The long term debt ratio is a measurement indicating the percentage of long-term debt among a company’s total assets.
  • The formula for long term debt ratio requires two variables: long term debt and total assets.
  • All debts are liabilities, but the opposite is not true. Therefore, you need to be careful when calculating long-term debt.
  • There’s no ideal value for long term debt ratio, it depends on each of industry’s standard.
  • Analysts usually compare the result of long term debt of a company’s with other businesses of the same type or with the company’s result to get a more comprehensive outlook.

Long Term Debt Ratio Calculator

You can use the long term debt ratio calculator below to quickly calculate the percentage of long-term debt among a company’s total assets by entering the required numbers.

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  • "Long Term Debt Ratio". StudyFinance.com. Accessed on September 23, 2021. https://studyfinance.com/long-term-debt-ratio/.

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