The capital structure of a business is the mix of types of debt and equity the company has on its balance sheet. The capital of a business can be evaluated by knowing how much of the ownership is in debt and how much in equity. The company's debt might include both short-term debt and long-term debt and equity, including common stock, preferred shares, and retained earnings. Capital structure concept is extremely important because it can influence not only the return a company earns for its shareholders, but whether or not a firm survives in a recession or depression. (Jean Murray, Joshua Kennon, 2010)
Financial statement analysis it is an helpful techniques which have no
significance only by reading the financial statement, being necessarily to calculate
financial ratios, interpreting those financial ratios, and also, by using other techniques
of financial analysis, such us horizontal analysis which reveals additional information
about financial strengths and weaknesses, or vertical analysis which shows financial
situation within a single accounting period.
The information contained in the financial statements is used and presents
interest for different categories of users like: managers, investors, suppliers and other
trade creditors, stockholders, financial analysts, government agencies. A number of
financial ratios can be computed from the information contained in the financial
statements. Financial ratios show financial relationship by dividing one financial item by
another, and are an important tool for management, permitting a space comparison to
place the company in her environment.
It is recommended that after financial ratios calculation to compare those ratios
with a standard.
Financial ratios analysis is used to find an answer of the following main
questions: is activity profitable, has the company enough money to pay its obligations,
how higher is wages level of its employees, company use its assets efficiently, has
company a gearing problem.
MIRELA MONEA, 2009. P137-138
Annals of the University of PetroÅŸani, Economics, 9(2), 2009, 137-144 FINANCIAL RATIOS - REVEAL HOW A BUSINESS IS DOING? MIRELA MONEA
-Interest Coverage Ratio
Interest cover measures net income against total interest payments. Debt accrues an interest charge, which the company has to finance. The interest cover ratio effectively measures a company's ability to service its debt. What shareholders don't want is for operating profits to be dissipated by a large interest bill. Theoretically, net income should cover interestat least one times, but that would mean all net income earned is used to ser\'ice debts- leaving no profit available for reinvestment into the business. Companies with an interest cover ratio of less than one times should definitely be avoided. If they can't pay interest it means they'll have to skimp on other crucial expenditure - and paying dividends isn't apriority (or possibility) at all. (ANDRÉ JANSE VAN VUUREN 25 Mar,2010 p.58)
FINWEEK, MEDIA24
Capitalization Ratio
Assumption:
1. Market Value of Total Debt = Market Value of Short term Debt
2. Adjusted capitalization includes short term debt
Indication: How reliant a company is on debt financing?
Result: PepsiCo's capitalization ratio is 18% and coca cola's capitalization ratio is only 2% which represents the lowest in group. Coca Cola Enterprises has the highest ratio of 52%. Cadbury Schweppes and McDonald's capitalization ratios are 15 and 13% respectively.
Capitalization ratios, also widely known as financial leverage ratios, provide a glimpse of a company's long term stability and ability to withstand losses and business downturns. By comparing debt to total capitalization, these ratios reflect the extent to which a corporation is trading on its equity, and the degree to which it finances operations with debt.
Financial leverage ratios present analysts and investors with an excellent picture of a company's situation, how much financial risk it has taken on, its dependence on debt, and developing trends. Knowing who controls a company's capital tells one who truly controls the enterprise.
A business finances its assets with either equity or debt. Financing with debt involves risk, since debt legally obligates a company to pay off the debt, plus the interest the debt incurs. Equity financing, on the other hand, does not obligate the company to pay anything. It pays investors dividends-but this is at the discretion of the board of directors. To be sure, business risk accompanies the operation of any enterprise. But how that enterprise opts to finance its operations-how it blends debt with equity-may heighten this risk.
• Capitalization ratio need to be evaluated over time, and compared with other data and standards.
• Capitalization ratio should be interpreted in the context of a company's earnings and cash flow, and those of its competitors.
.(QFinance)
Walsh, Ciaran. Key Management Ratios. 4th ed. London: FT Prentice Hall, 2008.
