Total Debt-to-Capitalization
Candlefocus EditorA company's total debt-to-capitalization ratio is calculated by dividing its total debt (long-term and short-term) by the sum of its debt and equity. It’s worth noting that this equation is used for debt and equity contributions from both inside and outside sources.
Total debt-to-capitalization is a key indicator of how a company finances its assets. A company’s capital structure is the combination of debt and equity used to fund its operations, and this metric is one way to gauge the balance between the two components. A higher ratio is an indication that a company is heavily reliant on debt to finance its assets, which can be an indication of higher risk. While debt can be a good way to increase return on equity, too much debt can lead to repayment issues in the long run, potentially leading to insolvency.
A company with a high ratio of debt relative to equity may not be able to finance its short-term obligations, and this lack of liquidity can contribute to long-term solvency risk. That said, a low debt-to-capitalization ratio can also be seen as an indication that a company is not taking full advantage of the lower cost of debt financing.
Overall, the debt-to-capitalization ratio can be a good measure for investors looking to assess a company’s financial health and risk profile. The ratio should indicate the company’s ability to cover its future obligations, and it can signal whether there are potential long-term issues with its capital structure. By comparing a company’s debt-to-capitalization ratio to its peers and industry standards, investors can gain a better understanding of the balance between debt and equity financing and make more informed decisions when evaluating potential investments.