Calculating Leverage Ratios

Systems and Coordination

Calculating Leverage Ratios

Leverage Ratios provide an indication of the long-term solvency of a business and highlight the extent to which long-term debt is used to support the business. Learn about calculating leverage ratios...

Dr. David L. HarkinsOctober 5, 2017

Leverage Ratios indicate long-term solvency of a business and highlight the extent to which long-term debt is used to support the business.

These ratios include:

DEBT-TO-EQUITY RATIO

The Debt-to-Equity Ratio measures how much debt is used to run a business and further highlights how much debt the business has for every dollar of equity. The formula is as follows:

Debt-to-Equity Ratio = Total Liabilities/Shareholders Equity

In most cases, investors would want to this ratio to hover around 1.0 or slightly less. Higher ratios suggest the company may be in financial distress, while lower number suggests the company is relying on equity financing which may be too costly and inefficient for the business.

DEBT-TO-ASSET RATIO

The Debt-to-Asset Ratio measures the percentage of a business's assets that are financed by creditors. The formula is as follows:

Debt-to-Asset Ratio = Short-Term Debt + Long-Term Debt/Total Assets

Most investors and lenders see a lower ratio as a good indicator to repay debt and take on new debt for new opportunities; a higher ratio might suggest financial weakness.

If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

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Reference

Rogers, S. (2014). Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur. New York: McGraw Hill Education.

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