The long-term debt ratio measures a company’s debt compared to its assets or equity, indicating its financial health and risk in a downturn. There are two interpretations, comparing debt to assets or shareholder equity. Credit lines can limit its utility, and long-term creditors are more interested in it than short-term creditors.
The long-term debt ratio is a measure of the amount of debt a company has compared to the value of its assets or equity. It’s not strictly a measure of solvency, but it gives an idea of a company’s fundamental financial health. A company with a high long-term debt ratio is more at risk in the event of a business downturn.
There are two potential interpretations of the long-term debt ratio. One compares long-term debt to the total value of a company’s assets. Another compares long-term debt with shareholder equity, which is made up of the company’s assets minus its liabilities. Since long-term debt is a key part of these liabilities, the two ratios are effectively different calculations to achieve largely similar analytical goals. However, it is important to ensure that any two specific ratio figures being compared were calculated in the same way.
When calculating the debt ratio, an analyst needs to distinguish between current liabilities and long-term liabilities. It is the last of these categories that covers long-term debt. Typically, the distinction is that current liabilities comprise debts that the company expects to pay in the next accounting period, most commonly the next year.
The utility of the long-term debt ratio is limited by the presence of credit lines. Long-term liabilities calculated in a company’s accounts will typically only cover the actual amounts owed, but the account will separately list the total credit available, for example, with an overdraft line or credit line from a vendor. These can influence the analyst’s assessment of the company. For example, it may seem that a company is too reliant on your overdraft, which may mean that the situation will get worse if there is still a large limit to use. Such factors are more difficult to quantify.
The long-term debt ratio will naturally be of greater interest to long-term creditors. Short-term creditors are generally more interested in cash flow, as this influences whether the money will be in the right place at the right time to pay them off. Long-term creditors are more interested in the big picture of the debt, as this gives an idea of whether the company is likely to be able to meet its obligations as a whole, and how much competition the creditor will have if the company is struggling to pay debts.
Smart Asset.
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