Capitalization Ratios

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.

  • Debt-Equity ratio = Total Debt / Shareholders' Equity                            
  • Long-term Debt to Capitalization = Long-Term Debt / (Long-Term Debt + Shareholders’ Equity)
  • Total Debt to Capitalization = Total Debt / (Total Debt + Shareholders' Equity) 

While a high capitalization ratio can increase the return on equity because of the tax shield of debt, a higher proportion of debt increases the risk of bankruptcy for a company.

Also known as leverage ratios.

BREAKING DOWN '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 –

  • Debt-Equity ratio = ($5 million + 25 million) / 50 million = 0.60 or 60%
  • Long-term Debt to Capitalization = $25 million / ($25 million + $50 million) = 0.33 or 33%
  • Total Debt to Capitalization = ($5 million + $25 million) / ($5 million + $25 million + $50 million) = 0.375 or 37.5%

The acceptable level of capitalization ratios for a company depends on the industry in which it operates. Companies in sectors such as utilities, pipelines and telecommunications – which are capital intensive and have predictable cash flows – will typically have capitalization ratios on the higher side. Conversely, companies with relatively few assets that can be pledged as collateral – in sectors like technology and retail – will have lower levels of debt and therefore lower capitalization ratios.

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.

RELATED TERMS
  1. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  2. Long-Term Debt To Capitalization ...

    A ratio showing the financial leverage of a firm, calculated ...
  3. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  4. Debt/Equity Ratio

    Debt/Equity Ratio is debt ratio used to measure a company's financial ...
  5. Total Debt-to-Capitalization Ratio

    An indicator that measures the total amount of debt in a company’s ...
  6. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
Related Articles
  1. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
  2. Credit & Loans

    Debt Ratios: Capitalization Ratio

    By Richard Loth (Contact | Biography)The capitalization ratio measures the debt component of a company's capital structure, or capitalization (i.e., the sum of long-term debt liabilities and ...
  3. Economics

    Calculating Long-Term Debt to Total Assets Ratio

    A company’s long-term debt to total assets ratio shows the percentage of its assets that are financed with long-term debt.
  4. Credit & Loans

    Debt Ratios: Introduction

    By Richard Loth (Contact | Biography)The third series of ratios in this tutorial are debt ratios. These ratios give users a general idea of the company's overall debt load as well as its mix ...
  5. Bonds & Fixed Income

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  6. Professionals

    Capital Structure

    This is an important concept in valuing a company.
  7. Active Trading Fundamentals

    Analyzing Oracle's Debt Ratios in 2016 (ORCL, SAP)

    Learn how the debt ratio, debt-to-equity ratio and debt-to-capital ratio are used to evaluate Oracle Corp.'s liabilities, equity and assets.
  8. Trading Strategies

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  9. Fundamental Analysis

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors understand how oil and gas firms are managing their debt.
  10. Investing Basics

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
RELATED FAQS
  1. What are the different capitalization ratios?

    Learn about capitalization ratios, three different ratios that measure debt in relation to capital structure and how to calculate ... Read Answer >>
  2. How can I use the debt-to-capital ratio to evaluate a stock?

    Understand the significance of the debt to capital ratio of financial leverage, and learn how investors and analysts make ... Read Answer >>
  3. Does a high debt to capital ratio make a company a bad investment?

    Understand the debt to capital ratio and why a high debt to capital ratio doesn't necessarily mean that a stock is a bad ... Read Answer >>
  4. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  5. What is a good debt ratio, and what is a bad debt ratio?

    Learn about the factors that influence how investors and lenders evaluate the debt ratio for a company and why the answer ... Read Answer >>
  6. What ratios are most commonly used to judge working capital management?

    Learn about the various working capital ratios that investors and analysts consider when evaluating a company's financial ... Read Answer >>
Hot Definitions
  1. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  2. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  3. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  4. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  5. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  6. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
Trading Center