 # Captial v/s Total Capital - Formula clarification

When the question says: calculate “Pre-tax return on capital” what is the formula i should use:

EBIT/ (Short term debt + long term debt + share holder equity) ?

or

EBIT / (Long term debt + share holder equity) ?

The reason i ask is -

Total capital = Current Liablities + (Short term debt + long term debt + Total share holder equity)

and only “Capital” is excluding current liabilities which is (Short term debt + long term debt + Total share holder equity) ?

I am confused here. Can some one clarify.

I don’t think total capital includes current liabilities. It’s sum of interest bearing liabilities and equity and whenever they talk abut capital in a ratio, it’s going to be this one only.

Agree with sgupta0827

Minority Interest?

Yes, Minority interest adjustment is different in both approaches.

Thanks Sgupta0827 for clarifying.

Here is my understanding: When they use the word “total” i though even current liabilities would be included for both the debt & capitilization formula.

The following is the formula from the CFAI material.

1. long-term debt-to-capitalization ratio =
long-term debt ------------------------------------------------------------------------------------------------------------ long-term debt+ minority interest + shareholders’ common and preferred equity
2. total debt-to-capitalization ratio =
current liabilities + long-term debt ------------------------------------------------------------------------------------------------------------ (current liabilities + long-term debt + minority interest + shareholders’ common and preferred equity) Please correct me if my understanding is wrong and appreciate your prompt response for the earlier post !

Please ignore my previous post. I don’t think I was clear enough in that.

Response to the second post:

Well Make sure you pay attention to asterisks. I am pretty sure wherever they have listed this formula, they must have mentioned what is included in the current liabilities. I am not disputing the fact that current liabilities are included in this formula. All I am saying is that these current liabilities are going to be interest bearing liabilities so you do account for notes payable and current portion of the debt but you don’t account for A/P or W/P.

Thank you Sgupta…

I don’t think that is correct sgupta… Have a look at reading 48 question 27. Total debt is the sum of current liabilities (including A/P) and long term debt. For total debt i would be including all current liabilities based on this.

@scatterbrain As far as I understand, there is a difference between “total debt” and “total capital”. In the question that you are pointing, “total debt” is being used, not the “total capital”. Total capital only accounts for long term and short term debt (only interest bearing) and of course equity. When you talk about debt, of course you will have to consider all your liabilities operational and long term.

I’m afraid that you get those ratio wrong. In general, when refer to Total debt or Total capital, we will ignore Non-interest bearing ( not that Total debt takes current liab into account but Total capital don’t )

those ratio listed by ganeshrpl are some kind of variations, so they have a little bit different definition. that’s all.

apr9th - i think we are on the same page.

Under the cash flow ratios in chapter 48, total debt (used in the debt payback period calc) includes A/P. I see though that in the FRA book, in the financial ratio list, A/P should not be included. I think this is what is the confusion. Can anyone clear this up?

I dont have the book infront of me, but isn’t the Debt Payback Period Calc part of the Debt Rating Section that S&P uses? They use different ratio’s from the ‘standard’. Like sgupta said, A/P’s etc should not be included in the standardized calcs.

Related question:

Can someone clarify invested capital, which I understand is different from total capital being discussed above?

Inv Cap = FC inv + NWC Inv = LT Debt + Equity + Preferred

@skwak88 Total capital and invested capital are the same thing. But I will be reluctant to use the second term of your equation as I haven’t seen this term being used in action, although I understand why they say that the 2nd term and 3rd term must be equal. The idea behind this is that all your net assets and net working capital must be funded through some part of debt and equity.

I don’t know if I agree with you sgupta. If total capital = total asset = total debt (including ST and LT debt) + equity, invested capital and total capital would not be the same, because invested capital excludes ST debt.

@skwak88 I don’t think your post is clear. But I think I get what you are saying. So the verdict is invested capital is (equity + LTD), total capital is (equity + STD + LTD) and the total debt is (current liabilities + long term liabilities). Let me know if you guys agree.

I need some serious clarification on this too. I’ve seen this come up two times, i believe both in Volume 5, fixed income, in two of the EOC questions.

The first time, it asked for long-term debt to total capitalization. The answers following the questions showed (L-T Debt)/(L-T Debt + Shareholder’s Equity) Note that there was short-term debt under current liabilities in the the B/S exhibit. That seemed horribly wrong to me since total capitlization should include any interest-bearing debt + shareholder’s equity.

The second time was on pg 311 of Volume 5, question 33 in the EOC. The B/S shows current liabilities of 120, L-T debt of 855 and Shareholder’s equity of 299. The question asks for Total debt to capitalization. It calculated it by doing (current liabilities + L-T debt) / (current liabilities + L-T debt + shareholder’s equity).

This topic appears very inconsistent to me. Anybody have any ideas? My understanding of finance leads me to believe total cap should just be ALL DEBT + S/H’s Equity. The numerator should then be either ALL DEBT or just L-T Debt.

It seems to me from your post rkuo, that if the numerator does not contain ST debt, the denominator won’t either. I have noticed this pattern, as well, and I am going with this from now.

So, in LTD debt/ Total Cap, Total Cap = LTD + Equity

In Total Debt/ Total Cap, Total Cap = STD + LTD + Equity