Leverage Ratio

Key Highlights

• A leverage ratio is a number that shows how much debt a company has compared to other key figures, like its equity (ownership value) or assets (what it owns).

• Common leverage ratios include debt-to-equity ratio (D/E), debt ratio, financial leverage ratio.

What is Leverage Ratio?

A leverage ratio is a number that shows how much debt a company has compared to other key figures, like its equity (ownership value) or assets (what it owns). It helps figure out how much a company relies on borrowed money versus its own funds, revealing its financial risk and how healthy its balance sheet is.

Common Leverage Ratios

1. Debt-to-Equity Ratio (D/E):

• Shows how much a company is relying on borrowed money compared to what the owners have invested.

2. Debt Ratio:

• Shows how much of a company’s assets are paid for with debt.

• This tells you what portion of the company’s stuff is funded by borrowing.

3. Financial Leverage Ratio:

• Compares total assets to total equity.

• It shows how much of the company’s assets come from equity versus debt.

What It Means?

• A ratio above 1 usually means more debt than equity or assets, which can signal higher risk.

• A lower ratio shows the company borrows less, which is safer but might limit growth.

• Compare ratios to other companies in the same industry, as “normal” varies by sector.

Why It Matters?

• Checking Risk: Leverage ratios help investors and lenders see if a company can handle its debt or if it’s at risk of financial trouble.

• Understanding Finances: They show how a company pays for its growth—through borrowing or its own funds—guiding decisions on taking loans or issuing shares.

• Planning Ahead: Management uses these ratios to balance debt and equity for tax savings, growth, and keeping shareholders happy.