Leverage Ratio
Candlefocus EditorThe most common leverage ratio is the debt-equity ratio. This measures a company’s relative financial health by showing the amount of debt in comparison to the company’s total equity. This ratio can help evaluate the level of risk that a company is taking on and its ability to withstand economic shocks. Generally, the higher the ratio, the higher the chance that the company may default on its debt.
The equity multiplier ratio is another important measure of a company’s leverage. This ratio is calculated by dividing total assets by total equity to measure how much shareholder equity is supporting the financial structure of the business. A high equity multiplier indicates that more debt is being borrowed to finance the company, which can be a sign of greater risk.
The degree of financial leverage ratio is a measure of the company’s ability to finance operations with debt. This ratio is calculated by taking the total liabilities divided by total equity and is expressed as a percentage. The higher this ratio, the greater the risk that the business is taking on.
There is also a consumer leverage ratio which looks at the ratio of total consumer debt to total consumer assets. The higher this ratio is, the more debt consumers have relative to income and assets. This ratio is an indicator of how much risk consumers may be taking on with their loans.
Overall, a company’s leverage ratio is an important tool in gauging its financial health. It can indicate how much debt the company has incurred and how reliant it may be on debt financing. In addition, it provides insight into how changes in output could affect operating income. Banks use leverage ratios as part of their risk management process, setting caps on the amount of debt each institution may take on. Knowing and understanding leverage ratios is an essential component of being an informed investor.