Capitalization Ratio

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Definition

The capitalization ratio compares total debt to total capitalization (capital structure). The capitalization ratio reflects the extent to which a company is operating on its equity.

Capitalization ratio is also known as the financial leverage ratio. It tells the investors about the extent to which the company is using its equity to support its operations and growth. This ratio helps in the assessment of risk. The companies with high capitalization ratio are considered to be risky because they are at a risk of insolvency if they fail to repay their debt on time. Companies with a high capitalization ratio may also find it difficult to get more loans in the future.

A high capitalization ratio is not always bad, however, higher financial leverage can increase the return on a shareholder’s investment because usually there are tax advantages associated with the borrowings.

Calculation (formula)

The capitalization ratio is calculated by dividing the long-term debt by the total shareholder’s equity and long–term debt. This can be expressed as:

Capitalization Ratio = Long-Term Debt / (Long-Term Debt + Shareholder’s Equity)

The capitalization ratio is a very meaningful debt ratio because it gives an important insight into the use of financial leverage by a company. It focuses on the relationship of long-term debt as a component of the company's total capital base. The total capital is the capital raised by the shareholders and the lenders.

The company’s capitalization (it should not be confused with the market capitalization) explains the make-up of the long-term capital of the company. Capitalization is also known as capital structure. A company’s long term capital consists of long - term borrowings and shareholder’s equity.

There is no standard or benchmark for setting the right or optimum amount of debt. Leverage will depend on the type of industry, line of business and the stage of development of the company (and its products). However, it is commonly understood that low debt and high equity levels in the capitalization ratio indicates good quality of investment. 

Quote Non accountant, 3 February, 2013
Short term  debt is missing in the formula. According to this definition, a company with a high short-term debt level could be seen as a safe company? Thanks.
Quote Vit. A., 3 February, 2013
Quote
Non accountant wrote:
Short term debt is missing in the formula. According to this definition, a company with a high short-term debt level could be seen as a safe company? Thanks.
Formula is correct, you should not take into account short term debt.
Quote Scarlet, 17 May, 2013
What if the comapny has no long term liability, how do you do the ratio then? What does that mean for the company?
Quote Vit. A., 17 May, 2013
Quote
Scarlet wrote:
What if the comapny has no long term liability, how do you do the ratio then? What does that mean for the company?
It depends on proportion between equity and short-terms debts. If there is a large share of short-terms debts, it's very-very bad.
Quote Guest, 23 July, 2013
what is the capital adequacy ratio and how can that be calculated from the consolidated balance sheet
Quote Ago, 25 August, 2013
Hello there! How can I find what the financial ratios DO NOT show us? I need a hand with that..
Quote Guest, 31 October, 2013
when formulas here mention "debt" do you mean liability or only loans ?

e.g. does long term debt = long term liabilities ? or only long term loans

Thanks
Quote Vit. A., 31 October, 2013
long term debt = long term liabilities
Quote Guest, 11 July, 2015
How to find out the time-duration (In years) of recovering it's long term debt, when company's long term debt is fixed and we have average Annual income of the company for only 2 years ?
Quote Larry, 17 March, 2016
How meaningful is the Capitalization Ratio if the company has negative equity?

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