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Capitalized ratios

Capitalized ratios, also known as capitalization ratios, are financial metrics that assess a company’s capital structure by comparing its debt to its equity or total capital. These ratios provide insights into a company’s financial leverage and its ability to meet its financial obligations.
Written by
Reviewed by
Updated on Jun 4, 2024
Reading time 3 minutes

3 Key Takeaways

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  • Capitalized ratios measure the proportion of debt in a company’s capital structure.
  • They are used to assess a company’s financial risk and its ability to repay its debts.
  • Common capitalized ratios include the debt-to-equity ratio, debt-to-capital ratio, and interest coverage ratio.

What are Capitalized Ratios?

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Capitalized ratios, also referred to as capitalization ratios, are financial metrics used to evaluate a company’s capital structure. They measure the extent to which a company uses debt financing compared to equity financing. These ratios are essential for assessing a company’s financial risk and its ability to meet its financial obligations, such as interest payments and debt repayment.

Importance of Capitalized Ratios

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  • Financial Risk Assessment: Capitalized ratios are crucial for evaluating a company’s financial risk. A higher proportion of debt in the capital structure indicates higher financial leverage, which can amplify both profits and losses.
  • Creditworthiness: Lenders and investors use capitalized ratios to assess a company’s creditworthiness. Companies with high debt levels may be considered riskier borrowers and may face higher interest rates.
  • Investment Decisions: Investors use capitalized ratios to assess the risk-return profile of potential investments. Companies with high debt levels may offer higher potential returns but also carry higher risk.
  • Financial Health: Capitalized ratios provide insights into a company’s overall financial health and its ability to manage its debt burden.

How Capitalized Ratios Work

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There are several commonly used capitalized ratios:

  1. Debt-to-Equity Ratio: This ratio compares a company’s total debt to its total equity. A higher ratio indicates higher financial leverage and greater financial risk.
  2. Debt-to-Capital Ratio: This ratio compares a company’s total debt to its total capital (debt plus equity). It provides a broader view of a company’s financial leverage than the debt-to-equity ratio.
  3. Interest Coverage Ratio: This ratio measures a company’s ability to pay interest on its debt. It is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expenses. A higher ratio indicates a greater capacity to cover interest payments.

Examples of Capitalized Ratios

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  • A company with £1 million in debt and £2 million in equity has a debt-to-equity ratio of 0.5.
  • A company with £1 million in debt and £3 million in total capital (debt plus equity) has a debt-to-capital ratio of 0.33.
  • A company with £500,000 in EBIT and £100,000 in interest expenses has an interest coverage ratio of 5.

Real-World Application

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Capitalized ratios are widely used by investors, lenders, and financial analysts to assess the financial health and risk profile of companies. These ratios are essential for making informed investment decisions, evaluating creditworthiness, and understanding a company’s ability to manage its debt obligations.


Sources & references

Arti

Arti

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Arti is a specialized AI Financial Assistant at Invezz, created to support the editorial team. He leverages both AI and the Invezz.com knowledge base, understands over 100,000 Invezz related data points, has read every piece of research, news and guidance we\'ve ever produced, and is trained to never make up new...