The common stock ratio measures the proportion of a company's total capitalization that is comprised of common stock. A high percentage indicates that company management is conservative, obtaining the bulk of the company's financing through the sale of common stock. A high common stock ratio is more necessary when cash flows are inconsistent, since it is then more difficult to support ongoing debt payments. The formula for the common stock ratio is to divide the book value of all common stock by the company capitalization. The calculation is:
Book value of common stock ÷ Total company capitalization = Common stock ratio
The numerator of this calculation includes both the par value and additional paid-in capital associated with all common stock sales, since the intent is to determine the total amount received from the sale of shares. The numerator does not employ the current market value of the shares sold, since this amount does not reflect the cash actually received by the business in exchange for the issuance of shares. The denominator includes all debt and equity of the business as of the measurement date.
For example, a company has sold $1,000,000 of common stock and also has $9,000,000 of debt obligations outstanding. This entity would be considered highly leveraged, since its common stock ratio is just 10%.