What is Leverage Ratio?

by Investing School on January 14, 2011

The term “leverage ratio” makes reference to a ratio that is calculated to figure out the financial leverage of a company. The leverage ratio offers a decent idea with regards to how the company is financing itself, as well as measuring its capabilities when it comes to meeting financial obligations.

The most important factors reviewed for leverage ratio calculations will include the company’s level of debt, the amount of equity, the presence of assets, as well as the total interest costs. These data will be calculated with a blend of the operating costs, providing a clearer image regarding how any financial output changes could influence the company’s operating income.

Of the leverage ratio calculations, probably the most commonly used is the debt-to-equity ratio. As an example, should a company have $15 million in debts, and $30 million in equity, it calculates out to a debt-to-equity ratio of 0.5 ($15M divided by $30M).

Because of the different types of calculations for leverage ratio, the meaning of the leverage ratio may differ significantly in the context for which it is used. As mentioned above, the ratio of debts to equity is common, but there are plenty of others, such as the ratio of debts (or long-term debts in particular, excluding for example accounts payable) to total assets. Leverage ratio is usually used to describe the leverage of a firm, but it can also be used to describe the financial accounts of another type of organization, individual, or group.

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