Why Look at a Company's Debt?

When picking a company for a long term investment it is important to look at many different factors of that company. One of which is the amount of debt the company has.
There are two major reasons you want to look at a company's debt.

1. How Long will it be around?

If a company has a ton of debt it may not be able to last very long. One little problem can hurt it and make it unable to pay the interest on those debts and the company might end up declaring bankruptcy. It is the same thing as looking at people. A person who has a ton of debt can be more in danger of getting in trouble then someone without all that debt.

2. Is the Company Making Money?

If a company is making good money there isn't a need to borrow too much money to finance its operations. Of course you only want to invest in companies that do make money so looking at the debt can help you here.

So how do you find out how much debt a company has and how much debt is too much? Well one great way of doing this is by looking at the debt to capital ratio.

This ratio allows you to determine how much debt the company has when compared to its total capital. So if the ratio is 30% that means 30% of the capital the company has is debt.

Obviously the less debt the company has the better the investment is. But to really understand it and to really use it you need to compare it with other companies in the same industry group. Most companies will have debt, but a company in the airline business will have more debt than say an internet business.

So comparing it with similar companies is important to make a good decision.