DEFINITION of ‘Capitalization Ratios’

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 –