Long-Term Assets to Long-Term Debt Ratio

Definition

The term long-term assets to long-term debt ratio refers to a measure that assesses the ability of a company to use noncurrent assets to pay down noncurrent debt. The long-term assets to long-term debt ratio allows the investor-analyst to understand if a company can pay off its liabilities using its assets.

Calculation

Long Term Assets to Long Term Debt Ratio = Noncurrent Assets / Noncurrent Liabilities

Where:

  • Noncurrent liabilities are those debt obligations that are not due for settlement in one year or business cycle. Examples of noncurrent liabilities include tax liabilities, bonds payable, long-term lease obligations, and bond liabilities.
  • Noncurrent assets are investments where the full value of the asset will not be realized in one year or business cycle. Examples of noncurrent assets include patents, goodwill, trademarks, and plant, property and equipment.

Explanation

Liquidity measures allow the investor-analyst to understand the company's long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand the overall liquidity position of a company is by calculating their long term assets to long term debt ratio.

The long term assets to long term debt ratio provides the investor-analyst, and lenders, with information in terms of the ability of a company to pay off its noncurrent liabilities using its noncurrent assets. Typically, an investor would like to see a value that is greater than 1.0. However, this assumes the only resources available to pay down debt are noncurrent assets. This is a serious flaw with this metric. The ratio also assumes a company would liquidate plant, property and equipment to pay off its loans. Even though the noncurrent assets should be net of accumulated depreciation (net book value), it is highly unlikely a company would use these assets unless it was in the process of liquidation.

Example

The manager of a large mutual fund would like to understand the ability of Company ABC to pay off its noncurrent debt using noncurrent liabilities. The manager knows the shortcomings of this ratio, and plans to use it to augment some of the other liquidity metrics his team has calculated. He asked his analytical team to gather information from Company ABC's balance sheet appearing in their most recent annual report.

His team found the following: plant, property and equipment of $56,312,000, goodwill of $12,513,000, and long-term debt of $84,760,000. The analysts reported the company's long-term assets to long-term debt ratio as:

= ($56,312,000 + $12,513,000) / $84,760,000
= $68,825,000 / $84,760,000, or 81%

The fund manager noted the ratio was under 1.0 (less than 100%) and asked his team to continue to look at additional liquidity metrics of Company ABC before making an investment decision.

Related Terms

defensive interval, risky asset conversion ratio, short-debt debt to long-term debt ratio, working capital to debt ratio