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Capital structure ratio

Method of calculation

Ratio's description

This ratio is the basic ratio of capital structure, calculated during the vertical analysis of the liabilities part of the balance sheet. It is used to assess the correctness of the equity level with respect to foreign capital (i.e. debt). The greater its value, the better (safer, with lower financial risk) the financial standing of the company, and consequently the better  the solvency and creditworthiness of the company (higher debt capacity indicates the ability of incurring new liabilities in the future). If the ratio's value is low it is recommended to perform debt structure analysis to check the reasons for high debt level: high long-term debt affects the solvency, while high short-term debt affects financial liquidity. Maintaining the ratio's value at a very high level is safe, but it lowers the operating profitability (the company does not use the positive financial leverage effects – the leverage allows to increase the equity profitability by increasing the debt levels).

Ratio's interpretation

  • The ratio should take values above 1 (it means that own financing prevails over foreign financing, i.e. debt).
  • Low ratio levels (below 1) are interpreted as substantial debt of the company and low creditworthiness (high ratio levels in turn are interpreted as low debt and high creditworthiness and debt capacity).
  • When assessing the changes in ratio's value over time (over few periods):
    • the increase of ratio's value is interpreted as an improvement of solvency and creditworthiness (due to the decrease of debt levels),
    • the decrease of ratio's value is interpreted respectively as a deterioration of solvency and creditworthiness.
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