there are several ratios in Assigned Reading #41 that involve total capital or total assets, e.g. return on total capital (EBIT / average total capital), or financial leverage (average total assets / average total equity). Schweser claims total capital = total equity. See Study Notes Book 3, page 281: “Total capital is the same as total assets.” In the same paragraph, they say “Total capital includes short- and long-term debt, preferred equity and common equity.” How can total capital = total assets? total capital includes only the items mentioned in the paragraph above. It does not include other items on the right side of the balance sheet, e.g. payables. What am I missing?
Payables are on the Liabilities side of the balance sheet. A = E + L A = Asset E = Equity L = Liabilities This is the age old Balance sheet equation. CP
total capital includes everything that goes into their capital structure. total assets is the first “big line” on the balance sheet, which includes current and non current assets
To CPK - using the framework you mention in your note, where does total capital fit in? the equation only works if total capital includes all liabilities and equity. and schweser explicitly says that total capital “includes short- and long-term debt, preferred equity and common equity.” it doesn’t say antyhing about other liabilities, like payables for instance.
total capital = total assets = total liabilities + equity total liabs = current liabs + long term liabs current liabs = short term debt, accounts payable, salaries payable, IT payable, etc. etc. long terms liabs = long term debt equity = common + preferred
It depends on context. Most people when they say “capital” are being loose with the language and are meaning equity capital which by definition is assets minus liabilities i.e. total capital = total equity. But financial ratios get distorted by capital structure so a common practice is to sum equity and debt holders together which is usually referred to as Enterprise Value (EV) so as to not confuse it with the equity value. And then run EBIT mults and what-not off of that, because it’s taken before interest it’s capital structure agnostic. Your assets are roughly speaking everything you own + everything you owe (all the money sunk into the business), so in that sense total capital = total assets. Technically you should also adjust debt by cash and equivs, but for most firms it’s not material enough to worry about. Those two ratios are related along that dimension. Return on Total Capital gives you a profitability data point without regard to cap structure (or as if it were financed 100% through equity) and the leverage ratio provides insight to the firm’s cap structure (a rough measure of the riskiness of it’s profits).
paul_ledin Wrote: ------------------------------------------------------- > common practice is to sum equity > and debt holders together which is usually > referred to as Enterprise Value (EV) so as to not > confuse it with the equity value. > EV also includes minority interests.
True enough, I was being loose with the language myself and assuming minority interests as part of equity.