DEFINITION of 'Capitalization Ratios'

Capitalization ratios are 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

    The debt ratio is a financial ratio that measures the extent ...
  2. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  3. Bond Ratio

    A bond ratio is a financial ratio that expresses the leverage ...
  4. Total Debt to Total Assets

    Total debt to total assets is a leverage ratio that defines the ...
  5. Funds From Operations (FFO) To ...

    Funds from operations (FFO) to total debt ratio is a leverage ...
  6. Accounting Ratio

    Accounting ratios, also known as financial ratios, are used to ...
Related Articles
  1. Investing

    Debt Ratios

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

    The Debt To Equity Ratio

    The debt to equity ratio identifies companies that are highly leveraged and therefore a higher risk for investors. Find out how this ratio is calculated and how you can use it to evaluate a stock.
  3. Investing

    Sysco and Other Big Movers In Services

    The market has been slipping so far today. The Nasdaq has fallen 0.3%; the S&P 500 has fallen 0.4%; and the Dow has declined 0.5%. The Services sector (IYC) is currently lagging behind the overall ...
  4. Investing

    Analyzing Apple's Debt Ratios in 2016 (AAPL)

    Discover detailed analyses of Apple's four debt ratios over quarterly and annual periods between 2014 and 2015, and learn why it is financially stable.
  5. Investing

    Analyzing Comcast's Debt Ratios in 2016 (CMCSA)

    Evaluate Comcast's most important debt ratios, and determine whether the company is using debt responsibly and capable of meeting obligations.
  6. Investing

    5 must-have metrics for value investors

    In this article, we outline the five ratios that can help value investors find the most undervalued stocks in the market.
  7. Investing

    Analyzing Verizon's Debt Ratios in 2016 (VZ)

    Analyze Verizon's key debt ratios, and understand how the company has been able to expand in recent years by safely increasing its debt load.
  8. Investing

    Key Financial Ratios to Analyze Investment Banks

    Find out which financial ratios are most useful when analyzing an investment bank, and why tracking capital efficiency is especially important.
RELATED FAQS
  1. What are financial risk ratios and how are they used to measure risk?

    Explore some of the primary financial risk ratios that investors and analysts commonly use to evaluate a company's overall ... Read Answer >>
  2. What is considered a good net debt-to-equity ratio?

    Learn about the maximum acceptable debt to equity ratio, what it means about a company's capital structure and why the optimal ... Read Answer >>
  3. What is the formula for calculating the current ratio?

    Find out what makes up the current ratio, how to calculate it, and what the result can tell you about a potential investment. Read Answer >>
  4. How do the current ratio and quick ratio differ?

    The current ratio and the quick ratio are both liquidity ratios that measure how a company's ability to pay off its short-liabilities ... Read Answer >>
Trading Center