What is Long-Term Debt-to-Equity?
When calculating the profitability of a business, it is essential to know the amount of debt a company has to pay. That's why this ratio is so important. It allows a company to measure how much money it can safely borrow over a long period of time.
How is it calculated?
The Long-Term Debt-to-Equity Ratio is calculated by comparing the total debt of the company (which includes both the short and long-term obligations), and then divides the total amount with shareholder equity. This number can be found at the bottom of the balance sheet, and it’s basically the difference that you can find between liabilities and assets. Simply put, this is the amount of money that remains for the stockholders once all the debt has been paid.
Why is the Long-Term Debt-to-Equity Ratio important?
The main idea of this ratio is that the more leverage a company has, the higher the resulting ratio. Most of the time, companies that have a high ratio are the ones bringing the most risk to the table. These companies are riskier because they have to bring principal as well as interest when it comes to their obligations. Different business types tend to have varying debt magnitude, depending on their field of work. For example, banks have liquid assets even if they have a high debt ratio. Manufacturers can’t afford a high ratio, because it would mean their earnings are unstable, but a utility can afford that without a problem.
This is very important to know because it allows any company to understand how of their operational money comes from debt. This makes it easy to see the effects of an interest rate increase or even insolvency. Depending on the situation, these can appear out of nowhere if the company is not prepared.
Most of the time, creditors want to see a low debt ratio because this means that their money will have better protection, and that’s crucial in today’s loan market. Of course, the ratio importance varies based on industry, with some industries being more affected than others. Most of the time, a ratio of 1:1 is enough for most companies no matter their field of work, but the ratio can change depending the nature of the business.