What Is the Bond Ratio?
The bond ratio is a financial ratio that expresses the leverage of a bond issuer by examining the value of bonds outstanding and when they come due. Leverage refers to any borrowed capital, such as debt issued in the form of bonds or other debts.
- The bond ratio is used to measure the financial leverage of a firm based on its level of long-term debt it has issued.
- The ratio divides the notional value of long-term bonds by a firm by its enterprise value, excluding cash or short-term debts.
- A bond ratio greater than one-third is indicative of above-average leverage taken on by a company.
Understanding the Bond Ratio
The bond ratio formally expresses the ratio of the bonds issued by a firm as a percentage of its total capital structure. Capital structure refers to how a company finances its operations and growth through the use of different sources of funding, namely debt and equity.
The numerator of the bond ratio captures the total value of any long-term bonds that the company has issued with maturity dates greater than one year. Short-term debt obligations, i.e. those with maturity dates in less than one year, are not considered in this calculation. The denominator captures the entirety of the firm's capital structure using its enterprise value (EV), but excluding cash and short-term debt. Enterprise value is a measure of a company's total value, often used as a more comprehensive alternative to equity market capitalization. EV includes in its calculation the market capitalization of a company but also its debts.
Bond Ratio = (Value of bonds due after one year)/(Value of bonds due after one year + value of equity capital)
Interpreting the Bond Ratio
Debt can be a more favorable means to finance operations because of its tax advantages. It also allows companies to retain ownership, unlike issuing equity, which allows outside shareholders to own a piece of the firm. Although debt has some advantages over equity in the capital structure, too much debt can become burdensome on any firm. If revenues decline for the firm, because of a recession or less demand for its products, for example, the firm will still be required to pay back its bondholders. The bond ratio allows investors to analyze the company's debt load and helps form an opinion on the firm's ability to repay its debts and avoid bankruptcy in the event of a decline in revenue.
Generally speaking, a bond ratio that exceeds 33% is viewed as above-average leverage. The typical exception to this applies to utility companies, which normally have ratios at this or a higher level. The bond ratio just is one of many ratios that are used to examine the financial health of bond issuers, and should be analyzed in conjunction with other ratio analysis. Since it is important to know how well a business is managing its debt, the following leverage ratios are also often used: Debt/EBITDA, EBIT/Interest Expense, and Debt-to-Equity (D/E) Ratio.