Total Debt-to-Capitalization Ratio

Total Debt-to-Capitalization Ratio

The total debt-to-capitalization ratio is a tool that measures the total amount of outstanding company debt as a percentage of the firm’s total capitalization. Total debt to capitalization \= ( S D \+ L T D ) ( S D \+ L T D \+ S E ) where: S D \= short-term debt L T D \= long-term debt S E \= shareholders’ equity \\begin{aligned} &\\text{Total debt to capitalization} = \\frac{(SD + LTD)}{(SD + LTD + SE)} \\\\ &\\textbf{where:}\\\\ &SD=\\text{short-term debt}\\\\ &LTD=\\text{long-term debt}\\\\ &SE=\\text{shareholders' equity}\\\\ \\end{aligned} Total debt to capitalization\=(SD+LTD+SE)(SD+LTD)where:SD\=short-term debtLTD\=long-term debtSE\=shareholders’ equity The firm’s debt-to-capitalization ratio would be computed as follows: **Total debt to capitalization:** ( $ 5  mill. \+ $ 2 0  mill. ) ( $ 5  mill. \+ $ 2 0  mill. \+ $ 1 5  mill. ) \= 0 . 6 2 5 \= 6 2 . 5 % \\frac{(\\$5 \\text{ mill.} + \\$20 \\text{ mill.})} {(\\$5 \\text{ mill.} + \\$20 \\text{ mill.} + \\$15 \\text{ mill.})} = 0.625 = 62.5\\% ($5 mill.+$20 mill.+$15 mill.)($5 mill.+$20 mill.)\=0.625\=62.5% ( $ 1 0  mill. \+ $ 3 0  mill. ) ( $ 1 0  mill. \+ $ 3 0  mill. \+ $ 6 0  mill. ) \= 0 . 4 \= 4 0 % \\frac{(\\$10 \\text{ mill.} + \\$30 \\text{ mill.})} {(\\$10 \\text{ mill.} + \\$30 \\text{ mill.} + \\$60 \\text{ mill.})} = 0.4 = 40\\% ($10 mill.+$30 mill.+$60 mill.)($10 mill.+$30 mill.)\=0.4\=40% This ratio indicates that 40% of the company’s capital structure consists of debt. The total debt-to-capitalization ratio is a tool that measures the total amount of outstanding company debt as a percentage of the firm’s total capitalization.

The total debt to capitalization ratio is a solvency measure that shows the proportion of debt a company uses to finance its assets, relative to the amount of equity used for the same purpose.

What Is the Total Debt-to-Capitalization Ratio?

The total debt-to-capitalization ratio is a tool that measures the total amount of outstanding company debt as a percentage of the firm’s total capitalization. The ratio is an indicator of the company's leverage, which is debt used to purchase assets.

Companies with higher debt must manage it carefully, ensuring enough cash flow is on hand to manage principal and interest payments on debt. Higher debt as a percentage of total capital means a company has a higher risk of insolvency.

The total debt to capitalization ratio is a solvency measure that shows the proportion of debt a company uses to finance its assets, relative to the amount of equity used for the same purpose.
A higher ratio result means that a company is more highly leveraged, which carries a higher risk of insolvency.

The Formula for the Total Debt-to-Capitalization Ratio Is

Total debt to capitalization = ( S D + L T D ) ( S D + L T D + S E ) where: S D = short-term debt L T D = long-term debt S E = shareholders’ equity \begin{aligned} &\text{Total debt to capitalization} = \frac{(SD + LTD)}{(SD + LTD + SE)} \\ &\textbf{where:}\\ &SD=\text{short-term debt}\\ &LTD=\text{long-term debt}\\ &SE=\text{shareholders' equity}\\ \end{aligned} Total debt to capitalization=(SD+LTD+SE)(SD+LTD)where:SD=short-term debtLTD=long-term debtSE=shareholders’ equity

What Does the Total Debt-to-Capitalization Ratio Tell You?

Every business uses assets to generate sales and profits, and capitalization refers to the amount of money raised to purchase assets. A business can raise money by issuing debt to creditors or by selling stock to shareholders. You can see the amount of capital raised as reported in the long-term debt and stockholders' equity accounts on a company's balance sheet.

Examples of the Total Debt-to-Capitalization Ratio in Use

Assume, for example, that company ABC has short-term debt of $10 million, long-term debt of $30 million and shareholders' equity of $60 million. The company's debt-to-capitalization ratio is calculated as follows:

Total debt-to-capitalization ratio:

( $ 1 0  mill. + $ 3 0  mill. ) ( $ 1 0  mill. + $ 3 0  mill. + $ 6 0  mill. ) = 0 . 4 = 4 0 % \frac{(\$10 \text{ mill.} + \$30 \text{ mill.})} {(\$10 \text{ mill.} + \$30 \text{ mill.} + \$60 \text{ mill.})} = 0.4 = 40\% ($10 mill.+$30 mill.+$60 mill.)($10 mill.+$30 mill.)=0.4=40%

This ratio indicates that 40% of the company’s capital structure consists of debt.

Consider the capital structure of another company, XYZ, which has short-term debt of $5 million, long-term debt of $20 million and shareholders' equity of $15 million. The firm’s debt-to-capitalization ratio would be computed as follows:

Total debt to capitalization:

( $ 5  mill. + $ 2 0  mill. ) ( $ 5  mill. + $ 2 0  mill. + $ 1 5  mill. ) = 0 . 6 2 5 = 6 2 . 5 % \frac{(\$5 \text{ mill.} + \$20 \text{ mill.})} {(\$5 \text{ mill.} + \$20 \text{ mill.} + \$15 \text{ mill.})} = 0.625 = 62.5\% ($5 mill.+$20 mill.+$15 mill.)($5 mill.+$20 mill.)=0.625=62.5%

Although XYZ has a lower dollar amount of total debt compared to ABC, $25 million versus $40 million, debt comprises a significantly larger part of its capital structure. In the event of an economic downturn, XYZ may have a difficult time making the interest payments on its debt, compared to firm ABC.

The acceptable level of total debt for a company depends on the industry in which it operates. While companies in capital-intensive sectors such as utilities, pipelines, and telecommunications are typically highly leveraged, their cash flows have a greater degree of predictability than companies in other sectors that generate less consistent earnings.

Related terms:

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. read more

Capital Structure

Capital structure is the particular combination of debt and equity used by a company to funds its ongoing operations and continue to grow. read more

Debt-To-Capital Ratio

The debt-to-capital ratio is calculated by dividing a company’s total debt by its total capital, which is total debt plus total shareholders’ equity. read more

Debt Ratio

The debt ratio is a fundamental analysis measure that looks at the extent of a company’s leverage. read more

Equity Accounting

Equity accounting is a method of accounting whereby a corporation records a portion of the undistributed profits for an affiliated entity holding. read more

Funded Debt

Funded debt is a company's debt that will mature in more than one year or one business cycle. read more

Insolvency

Insolvency is a situation in which an individual or company cannot pay off bills and debts. read more

Leverage : What Is Financial Leverage?

Leverage results from using borrowed capital as a source of funding when investing to expand a firm's asset base and generate returns on risk capital. read more

Leverage Ratio : Formula & Calculation

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or that assesses the ability of a company to meet financial obligations. read more

Liquidity Ratio

Liquidity ratios are a class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external capital. read more