This Cap Rate Calculator measures the financial leverage ratio (capitalization level) of a company which indicates the extent to which it is using the equity to run its operations and growth. The capitalization ratio formula together with some more information on this topic can be found below the tool.
How does this cap rate calculator work?
The algorithm behind this cap rate calculator is based on the formula explained here that takes account of these variables:
Long term debts (LTD) as defined in accountancy.
Shareholder’s equity (SHE).
Capitalization rate formula (CR) = LTD / (LTD + SHE)
Capitalization ratio definition
As it can be observed from its formula, the capitalization ratio measures the total debt of a company against its total capitalization or the so called capital structure. Also known as financial leverage ratio, it indicates to what extent a company is running its business by using its equity.
It is considered an important financial indicator in the eye of investors as it helps in the evaluation of the risk associated with running the business.
The interpretation of the capitalization rate level
Usually, entities registering a high capitalization ratio are classified as risky as they are exposed to the risk of insolvency case they don’t manage to pay in due time their debt. Moreover, in case of a high capitalization the probability to qualify for other debts if needed in the future is significantly smaller than in case of a lower capitalization rate.
However, when assessing a company from this point of view there are many other factors that should be regarded to get an accurate status. That is why a high capitalization ratio is not always a negative signal. For instance in case of a high profitable business that it manages with every extra piece of capital to produce better results, revenues and profits, then having a high capitalization rate may help. Needless to say that in most cases there are tax advantages associated with using borrowed capital.
Example of a calculation
In case of a company with these characteristics:
Long term debts = $460,000
Shareholder’s equity = $1,100,000
The capitalization rate that results is equal to 0.29 (or 29.49%)01 Dec, 2014