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Capitalization Ratio (Formula, Examples) | Calculation - YouTube
Channel: WallStreetMojo
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hello friends welcome to the investment
banking module of Wallstreetmojo
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today's topic is capitalization ratio
and friends as you all know that every
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ratio plays a very important role in the
financial analysis of any particular
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company capitalization ratio is one of
the most important ratio when we are
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deciding on the investment strategy of a
particular company and unlike other
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ratios capitalization ratio itself can
be divided into three parts basically
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capitalization ratio helps to evaluate
how much portion of the company's debt
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is invested into the business operations
that means out of the total capital of
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the company how much is the portion of
debt the company has and therefore the
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capitalization ratio can be divided into
three parts let us try to first
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understand what are the three different
capitalization ratio that we have been
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talking about the capitalization ratio
formula can be understood in three
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different parts or three different
formulas what are they number one debt
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to equity ratio number two long term
debt to capitalization ratio and number
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three total debt to capitalization ratio
and friends while each of these three
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formulas or each of these three ratios
holds at different importance in the
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ratio analysis but all the three can be
classified as capitalization ratio why
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because each of these three formula
basically helps to evaluate the
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proportion of debt to the total capital
of the country let us try to understand
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first what capitalization ratio means
capitalization ratio is primary tells us
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how the company is using that debt as
part of its financing strategy we have
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already discussed about it
basically using capitalization ratio we
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are able to identify how much debt the
company is using and total financial
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portion or total investment in the
company let us try to understand very
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briefly what each of these three
capitalization ratio helps us understand
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let us start a discussion with debt to
equity ratio
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what does debt to equity ratio means
debt to equity ratio is nothing but
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total debt divided by shareholders
equity as you all know that the capital
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of the company can be can be from two
sources one equity and the other sources
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is debt equity ratio basically helps
us identify how much portion of my total
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capital is dead for example if I am
saying a debt to equity ratio of a
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particular company is 2.5 is to 1 or if
I am saying the debt equity ratio of a
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company is 2.5 what does it mean it
means for every dollar of equity
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invested in the company the company has
2.5 dollars of debt let us try to
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understand this with the help of an
example suppose that debt of a company
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is $500,000 and equity of the same
company is say 7 $50,000 in that case
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what will be my debt to equity ratio my
debt to equity ratio will be $500,000
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/ 750000 dollars that
means 0.67 will be my debt to equity
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ratio and what it indicates it indicates
for every one dollar of equity invested
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in the company the total amount of debt
which is invested in the company will be
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0.67 dollars let us try to compute it
suppose in this case my equity was 750000
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dollars and there I am saying
what I'm saying the debt equity ratio
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indicates how much debt will be invested
in the company for every dollar of
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equity investor
so when I'm multiplying 750000
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dollars with the debt-to-equity ratio it
should give me 500,000
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dollars okay now this is about the debt
to equity ratio it helps us understand
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the capital structure of the company the
second ratio is long-term debt to
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capitalization ratio friends the debt
can be also divided into two parts
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short-term debt and long-term debt
short-term debt are those external
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borrowings which the company takes to
meet the short-term obligations of the
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company usually for a period of less
than 1 year and long-term debt is that
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debt which the company takes to meet its
long term liability or meet to fund its
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long term business requirement which is
usually more than a year that means a
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repayment schedule of those debts are
usually more than a year long-term debt
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to capitalization ratio holds important
in a sense that if I want to identify
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that out of my total capital or total
capital which is invested in the company
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how much is my long-term debt that is
very important because the repayment
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schedule of short term debt will be in
in a year and therefore we need to
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understand what is the portion of
long-term debt in my total capital okay
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capitalization ratio means long term
debt to capitalization ratio means long
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term debt divided by capitalization and
what does capitalization here means
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capitalization here means long term debt
and the shareholders equity that is
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called as capitalization so basically
this ratio means long term debt divided
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by long term debt plus shareholders
equity please note we are not
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considering short term debt over here
clear now moving on to the third and the
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last capitalization ratio which is total
debt to capitalization ratio this is no
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different than the second ratio which we
discussed the only difference is here we
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are talking about total debt that means
we are talking about both short-term
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debt
as well as long-term debt so the
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numerator will be total debt that means
short-term debt + long-term debt and
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the denominator will be long-term debt
+ short-term debt + shareholder
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equity here the definition of
capitalization is long-term debt +
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short-term debt + shareholders equity
friends we have understood about the
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formula let us try to understand with
the help of a practical example as you
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can see over here this is the chart of a
company debt to equity ratio and what
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what you can see the debt to equity
ratio of the company has increased
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significantly over the last 8 to 10
years and currently the debt to equity
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ratio of the company is 2.792 what does this indicate this
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indicate that for every dollar of equity
which is invested in the company the
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company has a debt of dollar
2.792 ok so this helps
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us understand how much leverage or how
much debt levered the company is how
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much is that portion of debt in the
company's total capital thank you
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