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What is Total Capitalization?
A company's total capitalization represents long-term debt obligations in addition to equity on a balance sheet. Also referred to as capital structure, total capitalization is what companies across industries depend on to fund expansions, projects and product development. Debt and equity are the two primary ways that a company accesses capital, and there are macroeconomic and internal corporate conditions that determine which form is appropriate to issue and when. By examining a company's total capitalization, investors and financial analysts are better able to assess the financial health of a balance sheet.
When a company decides to issue equity, there are different types of securities to choose from. All types of shareholder equity are reflected and detailed on a company's balance sheet to constitute a portion of total capitalization. Common stock is the most common form of equity, and it represents the number of shares that are issued in the financial markets for investors to buy and sell for a stock price. Investors obtain partial equity ownership of a company based on the percentage of shares owned. For each share of common stock held, an investor receives voting rights for major corporate events. Additionally, common shareholders become eligible for dividend distributions in the form of cash or additional stock on a quarterly or yearly basis.
Preferred stock also comprises a portion of total capitalization. These shares differ from common equity shares in that not as many shares are typically traded and the stock price does not fluctuate as much as common stock does. Unlike common stockholders, who earn profits from an appreciating stock price coupled with dividends, preferred shareholders generate much of their profits from consistent dividend distributions paid by a company at a predetermined rate.
Bonds constitute part of total capitalization on a company's balance sheet in the form of long-term debt obligations. These bond issues could last as long as 30 years. Companies issue debt, and investors become lenders.
A company must continue to pay investors ongoing interest payments out of total capital for the life of the bond until a maturity date. Before issuing debt, managers must be prepared to be disciplined with profits so that lenders are paid. In the event that a company is forced into bankruptcy and interest payments are missed, the largest bondholders could take control of the company. Too much debt on a balance sheet in relation to equity could damage a company's credit rating as issued by a third-party agency.
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Discussion Comments
@MrMoody - There’s only one figure I look at in any of my investments – and that is total net income. I think this is the number that drives stock price, more than debt obligations.
If income goes up, share prices go up, and everyone benefits. The company gets more capital and the investors can make more profits. All the other numbers mean little to me.
Sometimes analysts will parse a quarterly report, and even when there is good news, like an increase in net income, they may notice that profit margins have dwindled.
On that note, people start selling, but I don’t. As long as income goes up, I hold. Perhaps I’m a little simplistic but I’ve done okay for most of my investments so far.
@miriam98 - I’d like to point out that in those kinds of worst case scenarios sometimes the preferred stock holders get the better end of the deal.
No, they don’t get a great deal, but they’re better off than common share holders. This is the unique position that they have because of their preferred position.
When a company I worked for filed for bankruptcy, a lot of employees complained that it seemed the preferred shareholders were getting special privileges. Well, they were, that’s why they are called “preferred.”
Of course, if a company goes Chapter 7, there’s not much anyone can do, but here I am discussing Chapter 11 bankruptcy.
@everetra - Actually, debt is not that evil in a business sense. It’s just evil when you can’t ever pay it.
For many businesses total capitalization in the form of debt and stock shares is standard operating procedure to fund the business. It’s only when something catastrophic happens that the business picture changes and your total debt obligations become an albatross around your neck.
In one company I worked for, investors bailed in droves when they heard rumors that the company had been cooking the books. Of course if in fact a company plays funny with its numbers, they’re going to have more problems on their hands than what investors think.
In our case, the rumors turned out to be true, and the stock tanked until it was worthless. Overnight, billions of dollars of capitalization disappeared into thin air.
I worked for a company that was very infrastructure intensive. Therefore it had a high degree of debt in order to finance its continuing operations. It had capital too, in the form of equity in the business and stock shares, but its long term debt to total capitalization ratio was not healthy.
In other words, there was too much debt, not enough capital. There are numbers that financial analysts like to crunch that I don’t necessarily understand, but I (and other employees) understood two things: the amount of debt, and the total cash flow.
In short, we read the quarterly reports every month, and cash flow wasn’t keeping up with obligations. We also could tell that they had to pay down the debt pretty soon to keep operating.
Sure enough, they couldn’t do it, and the company filed for bankruptcy within fifteen months. The moral of the story is to pay down your debts.
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