Long Term Debt to Total Asset Ratio Definition
Long term debt to total asset ratio is the coverage or solvency ratio which is used to measure the leverage of the company by comparing the total debt to the asset.
In simple word, this ratio tells how much a company’s percentage of assets liquidate to pay off its long term debt.
On the balance sheet, the company has 2 types of liabilities, short liabilities, and long term liabilities.
Short term liabilities are those which due within 1 year and long term liabilities due for more than 1 years.
Definition: What is Long Term Debt Ratio?
By raising the debt or equity capital any company can build assets. From the long term debt to assets ratio you know how much percentage of assets finance via long term debt. If The ratio is high the company has fewer assets on the balance sheet and the company is more leveraged.
In other words, a high ration company needs to seel more asset for the elimination of its debt. For the payment of the debt, the company needs to generate high revenue and cash flow for a long time.
From this ratio management of the company or investors knows the financial stability of the company and all the risks of the company. Due to the high ratio investors worry because has less ability to finance its operations.
Long term debt to asset formula can be calculated by the dividing of long term debt to the total asset of the company.
Long term debt to total asset = long term debt/total asset
This is the simple formula because for the calculation we can get easily values of long term debt and total asset values from the balance sheet. Total assets mean the sum of tangible and nontangible assets of the company.
Long term debt means the liabilities which due for more than 1 year. For a better understanding of the calculation of this ratio now we take the example.
Now we take the example of the company of John which is the tools company. Financial data get from the balance sheet available in the below table for the previous 3 years. As compare to the debt of John his assets increase faster according to the information of table Because of which ratio decrease in last 3 years.
Now we take the example of 2 different companies which are Duck Energy and Southern Co. By using the section 10K we calculate the long term debt ratio which has results below.
During the period of 2014 to 2016 both company have over 0.6x LT debt ratio. It means that both companies fund their assets more as compared to debt.
Analysis and interpretation
Typically LT debt ratio is equal to 0.5 consider the healthy sign of the company. Analyzing this ratio for the industry under which company work is important. For capital intensive industry LT debt ratio will be high but for IT industries this ratio might be equal to zero because these companies sitting on the huge cash piles.
For the achieving of the optimal capital structure management want to guide the LT debt ratio is 0.5x for the next 5 years. to measure the execution capability of the management investor track the LT debt ratio for the next 5 years. Also, analyzer forecast the financial statement for 5 years out to check that the company achieve the desired capital structure or not.
Lender set covenant in place so that the lender can prevent the company from borrowing and much leveraged. As such covenant, this ratio LT debt is used. In this ratio, the lender selects the specific point above which restricted by the lender. Due to this management remain in the discipline because if the covenant debt has broken the for the company it is necessary to pay the debt immediately. which make cause for the negative financial of the company.
For more Financial Ratio Check:
Learn about Financial Ratios, Banking and Finance and feel better.