DEFINITION of 'Total DebttoCapitalization Ratio'
An indicator that measures the total amount of debt in a company’s capital structure. The totaldebttocapitalization ratio is a gauge of a company’s financial leverage, and is calculated as:
Leverage can be a doubleedged sword for a company. While a high totaldebttocapitalization ratio can increase shareholders’ return on equity because of the tax deductibility of interest payments, a higher proportion of debt reduces a company’s financial flexibility and increases the risk of insolvency. A lower debttocapitalization ratio may be preferable for most companies in order to keep the debt burden within easily manageable levels.
BREAKING DOWN 'Total DebttoCapitalization Ratio'
For example, consider company ABC with shortterm debt of $10 million, longterm debt of $30 million, and shareholders’ equity of $60 million. The company’s totaldebttocapitalization ratio would be computed as follows:
Total Debt to Capitalization = ($10 + 30) / ($10 + $30 + $60) = 0.4 or 40%.
This ratio indicates that 40% of the company’s capital structure consists of debt.
Now consider the capital structure of company XYZ, which has shortterm debt of $5 million, longterm debt of $20 million, and shareholders’ equity of $15 million. Its totaldebttocapitalization ratio would be computed as follows:
Total Debt to Capitalization = ($5 + 20) / ($5 + $20 + $15) = 0.625 or 62.5%.
Thus, although XYZ has a lower absolute level of total debt ($25 million versus $40 million), debt comprises a significantly larger part of its capital structure. In the event of an economic downturn, XYZ may have a difficult time making the interest payments on its debt.
The acceptable level of total debt for a company depends on the industry in which it operates. While companies in capitalintensive sectors like utilities, pipelines, and telecommunications are typically highly leveraged, their cash flows have a greater degree of predictability than companies in other sectors that are exposed to the economy’s cyclical fluctuations.

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