Total Debt-to-Capitalization Ratio

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.



comments powered by Disqus
Hot Definitions
  1. Benchmark Bond

    A bond that provides a standard against which the performance of other bonds can be measured. Government bonds are almost always used as benchmark bonds. Also referred to as "benchmark issue" or "bellwether issue".
  2. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
  3. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  4. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  5. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  6. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
Trading Center