In general, analysts use three different ratios to assess the financial strength of a company’s capitalization structure. The first two, the so-called debt and debt/equity ratios, are popular measurements; however, it’s the capitalization ratio that delivers the key insights to evaluating a company’s capital position.
The debt ratio compares total liabilities to total assets. Obviously, more of the former means less equity and, therefore, indicates a more leveraged position. The problem with this measurement is that it is too broad in scope, which, as a consequence, gives equal weight to operational and debt liabilities. The same criticism can be applied to the debt/equity ratio, which compares total liabilities to total shareholders’ equity. Current and non-current operational liabilities, particularly the latter, represent obligations that will be with the company forever. Also, unlike debt, there are no fixed payments of principal or interest attached to operational liabilities.
The capitalization ratio (total debt/total capitalization) compares the debt component of a company’s capital structure (the sum of obligations categorized as debt + total shareholders’ equity) to the equity component. Expressed as a percentage, a low number is indicative of a healthy equity cushion, which is always more desirable than a high percentage of debt.
Author:- Mr. B.K. gaur