Capitalization Ratios – Definition

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Capitalization Ratios Definition

Capitalization ratio is a financial metric that measures the solvency of a firm by examining its capital structure which is the combination of equity and debt. Often called cap ratio, this ratio measures the degree of debt in a company’s capital structure, it also shows the extent at which equity is used to finance a company’s operations. There are the common capitalization ratios, they are;

  • Debt to equity ratio
  • Long-term debt ratio to capitalization ratio
  • Debt to capitalization ratio

The capitalization ratio is otherwise called the financial leverage ratio. A high proportion of debt in a company signifies a possible insolvency or bankruptcy in the company while a high capitalization ratio means there is enough equity with which a company operates.

A Little More on What is a Capitalization Ratio

Capitalization ratios are important metrics used in calculating the total level of debt in a company’s capital structure, as well as the proportion of equity. Debt and equity are the major parts of capital structure for companies, this means a company can run its operations either with debt financing or equity financing. Capitalization ratios determine the financial leverage of a company by comparing the total debt with total equity. There are three major capitalization ratios and they are calculated as follows;

  • 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)

Through a capitalization ratio, an investor can know what type of capital structure exists in a company and whether a company funds its operations through debts or equity. Excess debt is not good for the company, it can lead to bankruptcy and eventual collapse of such form. Given the high risks attributed to debts, equity financing is more favorable for a business.

The acceptance level of capitalization ratios differ from one industry to another based on numerous factors including the tangible assets held by a company. Regardless of what this acceptance level, keeping a good track of capitalization ratios is what companies must place a premium on.

Reference for “Capitalization Ratios”

Academic research on “Capitalization Ratios”

The Effects of Operating Leases Capitalization on Financial Statements and Accounting Ratios: A Literature Survey, Akbulut, D. H. (2017). The Effects of Operating Leases Capitalization on Financial Statements and Accounting Ratios: A Literature Survey. In Regional Studies on Economic Growth, Financial Economics and Management (pp. 3-10). Springer, Cham. The purpose of this paper is to survey empirical papers about the effects of operating leases capitalization on accounting ratios and financial statements. In this paper, we focus on the new requirements and changes related to financial statements and we try to discover particularly the lessee accounting requirements. The paper analyses published research papers for the period between 2000 and 2015 which demonstrate the impact of the lease capitalization on accounting ratios and financial statements and these papers are mainly empirical studies. We extract the sample, ratios examined, findings and conclusions of these empirical studies. The results of these academic researches show that there is no common agreement. However the changes of lease accounting and the constructive capitalization of operating leases will mostly influence the financial statements and the key accounting ratios. In this paper, we focus deliberately the papers that assess the changes to lessee accounting because the new lease standard IFRS 16 Leases, which was published in 13 January 2016, substantially changed the lessees’ requirements. The paper lays out a current situation survey and gives brief information about the new lessee accounting and their impacts which are prospective to be worthwhile for users and preparers of financial reports, academics and researchers.

What About Public Utility Capitalization Ratios?, Hoskin, C. A. (1957). What About Public Utility Capitalization Ratios?. Financial Analysts Journal13(2), 39-44.

The Choice of Capitalization Ratios in Practice, Lawson, E. W. (1943). The Choice of Capitalization Ratios in Practice. Southern Economic Journal, 335-349.

Modelling a financial ratios categoric framework, Courtis, J. K. (1978). Modelling a financial ratios categoric framework. Journal of Business Finance & Accounting5(4), 371-386.

Stock market development and financial intermediaries: stylized facts, Demirgüç-Kunt, A., & Levine, R. (1996). Stock market development and financial intermediaries: stylized facts. The World Bank Economic Review10(2), 291-321. World stock markets are booming, and emerging stock markets account for a disproportionate share of this growth. Yet economists lack a common concept or measure of stock market development. This article collects and compares a broad array of indicators of stock market and financial intermediary development, using data from forty-four developing and industrial countries during the period from 1986 to 1993. The empirical results exhibit wide cross-country differences for each indicator as well as intuitively appealing correlations between various indicators. The article constructs aggregate indexes and analyzes them to document the relationship between the emergence of stock markets and the growth of financial intermediaries. It produces a set of stylized facts that facilitates and stimulates research into the links among stock markets, economic development, and corporate financing decisions.

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