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Capitalization Ratio

The capitalization ratio, or capital ratio, is a financial metric that measures a company’s ability to cover its liabilities with its assets. The finance team calculates this by dividing a company’s total liabilities by its total assets. Sometimes, accountants express the final result as a percentage while others leave them as decimals.

What Is the Capital Ratio Formula?

Knowing how to calculate total capitalization is an important skill for all managers to learn. There are two main ways to do this. Note that when completing the calculations, you can find everything you need on the balance sheet for your business.

This capitalization formula is the more complex of the two:

Total Capital Ratio = Total Debt / (Total Debt + Shareholder’s Equity)

This option is much simpler and requires no division:

Total Capital Ratio = Long-term Debt + Shareholders’ Equity

There is no one answer that creates a benchmark for good or bad capitalization. It tends to vary by market conditions, industry, and business size.

What Are the Limitations or Challenges When Reviewing Capitalization Data?

The source data comes from the balance sheet, but the values on a balance sheet and the actual cash value could vary. Because of this, capitalization formulas generate estimates instead of actual values. This sometimes creates room for error.

Another limitation is that the capitalization ratio doesn’t take into account the company’s future ability to generate revenue. For example, a company could take out loans to expand operations. This will expand revenue, but the ratio does not account for this. It shows only high current debt.

Because of these limitations, when reviewing the information, it’s important to balance it with other leverage ratios. The capital ratio turnover and capital structure ratio make good companions.

What Is a Capital Structure Ratio Formula?

This metric measures a company’s financial leverage. It tells you what portion of a company’s assets are financed by debt and what portion is financed by equity.

The capital structure ratio formula is:

Capital Structure Ratio = Total Liabilities / Total Equity

High capital structure ratios imply that a business has a lot of debt financing its operations. Low ratios mean that the company has a high percentage of equity financing. From a financial health perspective, equity financing is better than debt financing.

What Is the Capital Turnover Ratio?

This metric measures how efficiently a company is using its capital. The formula for this ratio is:

Capital Turnover Ratio = Total Sales / Shareholders Equity

This can help you identify inefficiencies in your company’s operations. A low ratio may indicate that your company is not generating enough sales to cover its expenses. A high ratio, on the other hand, could indicate that your company is overspending on operations.

How Can Automating the Accounts Receivables Process Improve the Capital Ratio?

If a company can improve its accounts receivable process by automating it, this will generate more cash. Cash is a key component of total assets, so any improvement in this area improves the capital ratio.

Gaviti provides software that tracks customer payments and sends automatic reminders when payments are due. This improves the inflow of cash and reduces the time it takes to collect payments from customers.

 

Those that are familiar with the workforce management space need no introduction to Monday.com and its powerful work OS tool. Monday.com recently moved to an automated accounts receivable (A/R) collection system, powered by Gaviti, to replace its outdated annual reporting methodology.

From Monday.com’s accounts receivables department:

With our business and sales growing exponentially, Gaviti has been a key tool in ensuring our DSO has not only stopped increasing but also shown improvements over a relatively short period of time. The ease of use combined with a highly responsive and helpful team… We have been able to quickly implement a comprehensive and versatile collections process.

When you stop to consider the broader, organizational benefits of automated A/R solutions, it’s easy to understand why Monday.com was so successful. The right A/R collection software can improve cash flow as well as the performance of key metrics – such as days sales outstanding (DSO) – within your organization.

Improve DSO Collection Processes

At its core, DSO collection is a cash flow problem. According to a U.S. Bank study, 82% of businesses fail due to poor cash flow management.

Part of this issue is attributable to the time-consuming processes inherent in manual collections. DSO collections and cash flow already vary from month to month. When you add the time spent managing spreadsheets across late payments, grace periods, and lines of credit, you have an untenable system where staff spends more time corralling reports than processing payments. And while you may not enjoy managing the nitty-gritty details of your business’s finances, your financial processes are ripe for optimization. Consider just a few ways that accounts receivable collection software can streamline your enterprise DSO:

  • Collect on accounts when they’re due with automated customer reminders
  • Create a single source of truth with a centralized A/R database that eliminates the need for tracking/compiling across different spreadsheets
  • Faster invoicing through the elimination of unnecessary payment delays
  • Standardize your process for consistent, repeatable collections every time
  • Streamline payment collection for clients, decreasing the odds of entry errors and making it more likely you’ll get paid on time

When you work to improve your accounts receivable collection, you’re working toward a healthy financial process where DSO stays low. But that’s not the only benefit of an A/R collection solution.

Stay Informed

5 Benefits of Automated Accounts Receivable Collection

In any discussion about the benefits of accounts receivable automation, it’s important to cover the broader benefits it provides:

  1. Better staff efficiency by reducing the manual hours required to perform collections tasks – all those hours you spend chasing invoices, calling clients, or writing follow-up emails add up.

  2. Ensure your data’s accuracy – real-time accurate data will prevent your company from making errors.

     

The benefits of the accounts receivable collection software are clear, and once you’ve deployed
automation,
you’ll have a hard time going back.

A/R Collections Best Practices

Although automated accounts receivable software brings a new dimension to your financial processes, the fundamentals of accounts receivable best practices remain the same. It’s a straightforward process that nevertheless tends to get bogged down by inefficiency. This is where automation software pays off.

Consider how you can leverage financial technology like this throughout your organization to improve key financial metrics. Technology is one option. Outsourcing accounts receivable collections to a service provider that can handle all the details for you is another. You have plenty of options, and now it’s just a matter of selecting which improvements will yield the best results for your enterprise.

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