When companies are analyzed, investors often calculate the company's market value capital structure. This is done primarily by using a ratio called the debt-to-equity ratio. A company's capital structure is made up of several key items including long-term debt, short-term debt, common equity and preferred equity. Capital structure tells whether a company is financed more through debt or through equity. Investors usually seek companies that are financed primarily through equity more so than companies financed through debt.
Step 1
Gather together a company's financial statements. The balance sheet of a company is what is needed specifically. A balance sheet is a summary of the company's assets, liabilities and equity. Each of the three categories, on the balance sheet, is then broke down into smaller sections, where assets are divided into current and fixed assets. Liabilities are narrowed down into categories consisting of short-term and long-term debts. The equity section is broke down into types of equity.
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Step 2
Add up the total liabilities of the company. This is done to calculate the market value of the capital structure. Liabilities are all debts owed by the company. Some liabilities are considered short term, which means they are due and payable within one year. Others are long term, meaning that they are not due for at least one year. Some companies choose to only include long-term liabilities in this calculation because it reveals a more accurate capital structure.
Step 3
Total the shareholder's equity in the business. This includes all common stock, preferred stock and any corporate bonds issued. The total amount represents how much money the company has borrowed from shareholders. This is considered the equity amount in the company's capital structure.
Step 4
Divide the numbers. Divide the total liabilities amount by the shareholder's equity. The answer reveals the capital structure of the company. This shows what percentage of the capital is financed by debt and what percentage is financed by equity--called the debt-to-equity ratio. Companies financed primarily by equity are less risky than companies that are financed by debt, because equity is a more stable way of expanding business operations than debt. For example, if a company has $300,000 in liabilities and $600,000 in equity, the total capital is $900,000. Dividing the liabilities by the equity results in a debt-to-equity ratio of 0.5 or 50 percent. This means that 50 percent of the company's capital is financed with debt. The lower the percentage is, the less risky the company is.
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