Debt to Capital Employed Ratio

The Debt to Capital Employed Ratio measures the proportion of long-term debt in the total long-term funds of the business. It tells you how much of the capital employed (the money used to run the business) has come from borrowed sources versus owners' funds.

Computation

The formula is:

Debt to Capital Employed Ratio = Long-term Debt / Capital Employed (or Net Assets)

Capital Employed can be calculated in two ways, both giving the same figure:

• Method 1: Long-term Debt + Shareholders' Funds
• Method 2: Total Assets – Current Liabilities (this gives Net Assets, which equals Capital Employed)

Long-term Debt includes all borrowings repayable after one year — debentures, long-term loans from banks or financial institutions, etc.

Example using the textbook data (Illustration 7):

• Long-term Debt = ₹5,00,000
• Shareholders' Funds = ₹15,00,000
• Total Assets = ₹25,00,000
• Current Liabilities = ₹5,00,000

Capital Employed (Method 1) = ₹5,00,000 + ₹15,00,000 = ₹20,00,000

Capital Employed (Method 2) = ₹25,00,000 – ₹5,00,000 = ₹20,00,000

Debt to Capital Employed Ratio = ₹5,00,000 / ₹20,00,000 = 0.25 : 1

This means that for every ₹1 of capital employed, 25 paise comes from long-term debt.

Significance

This ratio serves the same purpose as the Debt-Equity Ratio — it shows the proportion of long-term debt in the total funding structure.

• Low ratio (like 0.25:1) provides security to lenders. The business is not heavily dependent on borrowed funds, so creditors feel safe.
• High ratio helps management in trading on equity — using borrowed funds to increase returns to shareholders. However, a very high ratio increases financial risk.

In the example above, the ratio is less than half (0.25 < 0.50), which indicates reasonable funding by debt and adequate security for debt holders.

Important Distinction

The textbook notes that this ratio can also be computed in relation to total assets. In that case, the formula changes:

Debt to Capital Employed Ratio (in relation to total assets) = Total Debts / Total Assets …