Financial Leverage Ratios

A leverage ratio is one of any financial measurements that analyzes how much capital is introduced in the form of debt (loans) and examines the ability of a company to meet its financial obligations. The leverage ratio is essential given that companies depends on a blend of equity and debt to finance their operations and knowing the amount of debt held by a company is important for evaluating whether it can pay its debts off as they come due.

Put simply, the financial leverage ratios calculates the total debt load of a company and compare it with the assets or equity. This shows the shareholders contribution in assets. When shareholders own a majority of the assets as compared to the creditors, the company is said to be less leveraged. When creditors own a majority of the assets, the company is considered highly leveraged.

Debt Ratio

Debt ratio is a solvency ratio that helps to calculate a company's total liabilities as a percentage of its total assets. Basically, the debt ratio displays a company's ability to pay off its liabilities with its assets. Put simply, debt ratio helps to find how many assets the company needs to sell in order to pay off all of its liabilities.

The formula to calculate debt ratio is:

Debt Ratio = Total Liabilities/Total Assets

Debt to Equity Ratio

The debt to equity ratio compares a company's total debt to total equity. The debt to equity ratio displays the percentage of finance that the company receives from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).

Formula to calculate Debt to Equity Ratio is:

Debt to Equity Ratio = Total Liabilities/Total Equity

Equity Ratio

The equity ratio measures the amount of assets that are financed by owners' investments by comparing the total equity in the company to the total assets.

To calculate equity ratio, following formula can be applied:

Equity Ratio = Total Equity/Total Assets

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