Total Debt-to-Capitalization Ratio

AAA

DEFINITION of 'Total Debt-to-Capitalization Ratio'

An indicator that measures the total amount of debt in a company’s capital structure. The total-debt-to-capitalization ratio is a gauge of a company’s financial leverage, and is calculated as:

Leverage can be a double-edged sword for a company. While a high total-debt-to-capitalization 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 debt-to-capitalization ratio may be preferable for most companies in order to keep the debt burden within easily manageable levels.

INVESTOPEDIA EXPLAINS 'Total Debt-to-Capitalization Ratio'

For example, consider company ABC with short-term debt of $10 million, long-term debt of $30 million, and shareholders’ equity of $60 million. The company’s total-debt-to-capitalization 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 short-term debt of $5 million, long-term debt of $20 million, and shareholders’ equity of $15 million. Its total-debt-to-capitalization 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 capital-intensive 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.

RELATED TERMS
  1. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company ...
  2. Funds From Operations (FFO) To ...

    A leverage ratio that a credit rating agency or an investor can ...
  3. Cash Flow-to-Debt Ratio

    A ratio of a company’s cash flow from operations to its total ...
  4. Degree Of Financial Leverage - ...

    A ratio that measures the sensitivity of a company’s earnings ...
  5. Total Debt To Total Assets

    A measure of financial risk that determines the proportion of ...
  6. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
RELATED FAQS
  1. What are some strategies companies commonly use to reduce their debt to capital ratio?

    Companies can take steps to reduce and improve their debt to capital ratios. Among the strategies that can be employed are ... Read Full Answer >>
  2. How do you calculate the geometric mean to assess portfolio performance?

    The geometric mean is used to calculate the central tendency of a set of numbers. It is the average of the logarithmic values ... Read Full Answer >>
  3. What does the operating cash flow ratio measure?

    The operating cash flow ratio measures a company's ability to meet its short-term, or current, liabilities, also known as ... Read Full Answer >>
  4. What's the difference between the coverage ratio and the levered free cash flow to ...

    Coverage ratios focus on a company’s ability to manage its debt, while the levered free cash flow to enterprise value ratio ... Read Full Answer >>
  5. What are the different sources of business risk?

    A certain risk level is inherent in running a business. A company cannot completely eliminate risk, but it can control or ... Read Full Answer >>
  6. What are some ways a company can improve on its Return on Capital Employed (ROCE)?

    Options available to a company seeking to improve on its return on capital employed (ROCE) ratio include reducing costs, ... Read Full Answer >>
Related Articles
  1. Investing Basics

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  2. Home & Auto

    Leveraging Leverage For Bigger Profits

    Leverage is like fire. Find out how to use it to heat up your investing without burning your portfolio.
  3. Fundamental Analysis

    Analyzing Investments With Solvency Ratios

    Solvency ratios are extremely useful in helping analyze a firm’s ability to meet its long-term obligations; but like most financial ratios, they must be used in the context of an overall company ...
  4. Investing Basics

    The Optimal Use Of Financial Leverage In A Corporate Capital Structure

    The amount of debt and equity that makes up a company's capital structure has many risk and return implications.
  5. Fundamental Analysis

    Financial Analysis: Solvency Vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health. A number of financial ratios are used to measure a company’s liquidity and solvency, and an investor should use ...
  6. Fundamental Analysis

    An Introduction To Coverage Ratios

    Interest coverage ratios help determine a company's ability to pay down its debt.
  7. 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, ...
  8. Investing Basics

    Leverage: What It Is And How It Works

    Leverage is an investment strategy of using borrowed money to generate outsized investment returns. Before getting into greater detail on how leverage works in an investment context, it is useful ...
  9. Forex Education

    Forex Leverage: A Double-Edged Sword

    Find out how this flexible and customizable tool magnifies both gains and losses.
  10. Credit & Loans

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.

You May Also Like

Hot Definitions
  1. Fisher Effect

    An economic theory proposed by economist Irving Fisher that describes the relationship between inflation and both real and ...
  2. Fiduciary

    1. A person legally appointed and authorized to hold assets in trust for another person. The fiduciary manages the assets ...
  3. Expected Return

    The amount one would anticipate receiving on an investment that has various known or expected rates of return. For example, ...
  4. Carrying Value

    An accounting measure of value, where the value of an asset or a company is based on the figures in the company's balance ...
  5. Capital Account

    A national account that shows the net change in asset ownership for a nation. The capital account is the net result of public ...
  6. Brand Equity

    The value premium that a company realizes from a product with a recognizable name as compared to its generic equivalent. ...
Trading Center