What it means
The ratio answers a simple question about the capital structure. Of all the long-term money keeping this business running, how much of it has to be repaid to bondholders regardless of how trading goes.
It matters because bonds carry fixed obligations. Interest must be paid whether profits are strong or weak, and the principal must be repaid at maturity, so a company with a high bond ratio has less room to absorb a bad year than one funded mainly by equity.
Analysts read the ratio alongside the industry it sits in. Utilities and infrastructure operators often run bond ratios of 45% to 60% because their revenues are stable and predictable, while a software company with volatile earnings might be considered stretched above 25%.
The calculation only includes long-term capital. Short-term bank overdrafts, trade payables and other current liabilities are excluded, which keeps the ratio focused on permanent funding rather than working capital swings.
Two variations cause confusion in meetings. Some analysts use all long-term debt rather than bonds alone, and some exclude preferred stock from the denominator, so it is worth asking which definition a report has used before comparing two companies.
Lenders and rating agencies often write the ratio into loan documents as a hard limit. A covenant capping the bond ratio at, say, 55% means the company cannot keep borrowing indefinitely, and breaching the cap can trigger penalty interest or immediate repayment.
In practice
Real-world examples.
Example
A regional power utility reports a bond ratio of 52% and its lenders barely blink, because regulated revenues make the interest bill highly predictable. A consultancy with the same ratio would face far tougher questions from its bank.
Example
A private equity buyer refinances an acquisition target, replacing equity with bonds and pushing the bond ratio from 30% to 58%. Returns on equity improve while trading is strong, but the margin for error narrows considerably.
Example
A family-owned packaging group deliberately keeps its bond ratio below 25% so it can borrow quickly if a competitor comes up for sale. Directors describe the unused borrowing room as strategic capacity rather than caution, and they have used it twice in a decade to fund acquisitions without going back to shareholders for money.
Formula
Calculation
Bond ratio = bonds outstanding / total capitalisation
Total capitalisation = bonds + preferred stock + common shareholders' equity
A company's balance sheet shows $8,000,000 of long-term bonds, $2,000,000 of preferred stock and $10,000,000 of common shareholders' equity. Total capitalisation is $8,000,000 + $2,000,000 + $10,000,000 = $20,000,000.
The bond ratio is $8,000,000 / $20,000,000 = 0.40, or 40%. In plain terms, 40 cents of every dollar of long-term funding in the business has been borrowed from bondholders and carries a repayment date.
If the company then issued a further $4,000,000 of bonds without raising equity, bonds would rise to $12,000,000 and total capitalisation to $24,000,000, lifting the ratio to $12,000,000 / $24,000,000 = 50%. The same profits would now have to service half as much again in fixed interest.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Tallow Creek Utilities, an invented water company, reported $180,000,000 of bonds, $20,000,000 of preferred stock and $200,000,000 of common equity. Total capitalisation was $180,000,000 + $20,000,000 + $200,000,000 = $400,000,000, giving a bond ratio of $180,000,000 / $400,000,000 = 45%.
The board then approved a $60,000,000 bond issue to replace two pumping stations, funded entirely with debt because the family shareholders did not want their stake diluted. Bonds rose to $240,000,000 and total capitalisation to $460,000,000, so the ratio moved to $240,000,000 / $460,000,000 = 52.2%.
The company's bond covenants capped the ratio at 55%, which meant the fictional business had used most of its remaining headroom in one decision. When a storm damaged a reservoir eighteen months later, there was no capacity left to borrow, and the shareholders had to accept the equity injection they had been avoiding all along.
Watch out
Common mistakes.
- Including short-term borrowings and payables in the calculation, which inflates the ratio and makes comparisons with published figures meaningless.
- Judging a ratio in isolation rather than against the sector, so a normal utility figure gets flagged as dangerous and a risky technology figure looks fine.
- Using book equity without asking whether it is realistic, since heavily written-down assets can make the equity base look artificially small and the ratio artificially high.
Questions
People also ask.
Is a low bond ratio always better?
Not necessarily. Some borrowing is usually cheaper than equity, so a very low ratio can mean the business is passing up affordable funding.
How does the bond ratio differ from the debt to equity ratio?
The bond ratio expresses bonds as a share of total long-term capital, while debt to equity compares borrowings directly against shareholders' funds, producing a larger and less bounded number.
Where do I find the numbers?
Bonds and preferred stock appear on the balance sheet under non-current liabilities and equity respectively, with detail on maturities in the notes to the accounts.
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