Companies can take steps to reduce and improve their debt to capital ratios. Among the strategies that can be employed are increasing sales profitability, better management of inventory and restructuring debt.
The debt to capital ratio is a financial leverage ratio, similar to the debt to equity (D/E) ratio, that compares a company’s total debt to its total capital composed of debt financing and equity. This metric provides an indication of a company’s overall financial soundness, as well as revealing the proportionate levels of debt and equity financing. A value of 0.5 or less is considered good, while any value greater than 1 shows a company as being technically insolvent.
The most logical step a company can take to reduce its debt to capital ratio is that of increasing sales revenues and profitability. This can be achieved by raising prices, increasing sales or reducing costs. The extra cash generated can then be used to pay off existing debt.
Another measure that can be taken to reduce the debt to capital ratio is more effective management of inventory. Inventory can take up a very sizable amount of a company’s working capital. Maintaining unnecessarily high levels of inventory beyond what is required to fill customer orders in a timely fashion is a waste of cash flow. Companies can examine the days sales of inventory (DSI) ratio, part of the cash conversion cycle (CCC), to determine how efficiently inventory is being managed.
Restructuring debt provides another way to increase capital and reduce the debt to capital ratio. If a company is largely financed at high interest rates, and current interest rates are significantly lower, the company can seek to refinance its existing debt at lower rates. This will reduce both interest expenses and monthly payments, improving the company’s bottom-line profitability and improve cash flow.