What is a Long-Term Debt Ratio?

John Lister
John Lister
Man with hands on his hips
Man with hands on his hips

The long-term debt ratio is a measure of how much debt a company carries compared with the value of its assets or its equity. It is not strictly a measure of solvency, but it does give an insight into the fundamental financial health of a company. 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 long-term debt ratio. One compares long-term debt with the total value of a company's assets. Another compares long-term debt with the shareholder equity, which is made up of the company's assets minus its liabilities. As long-term debt is a key part of these liabilities, the two ratios are effectively different calculations to reach largely similar analytical goals. It is important, though, to make sure two specific ratio figures under comparison were worked out in the same way.

When calculating the debt ratio, an analyst needs to distinguish between current and long-term liabilities. It is the latter of these categories that covers long-term debts. Usually the distinction is that current liabilities comprise debts that the company expects to repay in the next accounting period, most commonly the coming year.

The usefulness of the long-term debt ratio is limited by the presence of credit facilities. The long-term liabilities figured in a company's accounts will usually only cover the actual amounts owed, but the account will separately list the total credit available, for example with an overdraft facility or a credit line from a supplier. These may influence the analyst's assessment of the company. For example, a company may appear to be relying too heavily on its overdraft, which may mean the situation will get worse if there is a large limit still to use. Such factors are harder to quantify.

The long-term debt ratio will naturally be of most 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 repay them. Long-term creditors are more interested in the overall picture of debt, as this gives an insight into 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 repay debts.

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