Formula: Liabilities including Finance lease and Defined Benefit Plans if any / Equity including Preferred Stocks, Undistributed Profits + Liabilities
Capital is significant for the growth of any company. It is like starting point of any company with which it will start its life. It could be working capital or capital for the long term, like equity or debt.
Why is this Ratio essential? Because Debt capital is borrowed capital. Shareholders do not own it. So when the company is making assets with the help of borrowed money, it is supposed to take care of servicing the funds, or else the Bank or Debenture holder is the owner of such asset.
If a company’s capital structure has a large percentage of debt, it may not be a good sign as bankers hold first right on assets.
But in some types of business, high leverage is essential, like banking. You need to borrow funds; that is how banks will do business. Here I want to clarify that ratios used in banking are different stories. This Ratio is not for banks but manufacturing companies as Service sector companies hardly need to take any debt on their balance sheet.
