Definition of 'Capitalization Ratios'
Indicators that measure the proportion of debt in a company’s capital structure. Capitalization ratios include the debt-equity ratio, long-term debt to capitalization ratio and total debt to capitalization ratio. The formula for each of these ratios is shown below.
Also known as leverage ratios.
Investopedia explains 'Capitalization Ratios'
For example, consider a company with short-term debt of $5 million, long-term debt of $25 million and shareholders’ equity of $50 million. The company’s capitalization ratios would be computed as follows –
The acceptable level of debt for a company is dependent on its whether its cash flows are adequate to service such debt. The interest coverage ratio, another popular leverage ratio, measures the ratio of a company’s earnings before interest and taxes (EBIT) to its interest expense. A ratio of 2, for instance, indicates the company generates $2 for every dollar in interest expense.
As with all ratios, a company’s capitalization ratios should be tracked over time to identify if they are stable. They should also be compared with similar ratios of peer companies, to ascertain the company’s leverage position relative to its peers.