LEVERAGE RATIO

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A leverage ratio is a financial measurement that looks at how much capital comes in the form of debt (loans), or assesses the ability of a company to meet its financial obligations. It is commonly referred to as debt to equity ratio, and it is expressed as:
D/E Ratio = Total Debt/ Total Equity

Leverage ratio represents the extent to which a business is utilizing borrowed money. It also evaluates company solvency and capital structure. Having high leverage in a company’s capital structure can be risky, if not well-utilized .

The use of leverage is beneficial during times when the company is earning profits, as they become amplified. On the other hand, a highly levered company will have trouble if it experiences a decline in profitability and may be at a higher risk of default than an unlevered or less levered company in the same situation.

Therefore, analysing the existing level of debt is an important factor that creditors consider when a company wishes to apply for further borrowing.

Investdata Academy

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