Funded Capital Ratio
The term funded capital ratio refers to a measure that allows the investor-analyst to understand how much of the company’s fixed assets were purchased using long term funding. The funded capital ratio allows the investor-analyst to better understand a company’s cost of debt.
Funded Capital Ratio = (Stockholder’s Equity + Long-Term Debt) / Fixed Assets
- Fixed assets are typically shown on the balance sheet net of depreciation, and may also include a salvage value. This can cause some problems for the analyst when examining this ratio since it may understate the actual value of fixed assets.
Capital structure and solvency measures allow the investor-analyst to understand the company’s ability to remain in business in the long term. This is usually assessed by examining the relationship between debt, equity and the proportions of different types of stock. Solvency is the ability to continue operating, which oftentimes depends on cash flow. One of the ways to understand the overall capital structure of a company is by calculating their funded capital ratio.
The funded capital ratio provides the investor-analyst with information in terms of the company’s cost of borrowing. For example, if the ratio is considerably lower than 100%, then the company may be using more expensive forms of funding for capital purchases. Typically, long term debt and stockholder’s equity are a company’s lowest cost options. Relying on short-term debt to finance capital projects can put a company at risk, especially when interest rates are at historical highs or on the rise.
The manager of a large mutual fund would like to better understand Company ABC’s cost of capital. The manager has a concern the company is using short-term debt to fund its capital purchases. He asked his analytical team to pull the company’s latest 10K and calculate their funded capital ratio. The team found the following: fixed assets at $65,700,000, long-term debt at $22,600,000, and shareholder’s equity at $37,500,000. The funded capital ratio would then be:
= ($37,500,000 + $22,600,000) / $65,700,000= $60,100,000 / $65,700,000, or 91.5%
Given how close the ratio is to 100%, the mutual fund manager asked his team to evaluate some additional solvency and capital structure metrics to better understand if Company ABC is in a financially stressed state.