Leverage Ratios:

Leverage ratios measure how much debt a firm has and how much protection does a company’s assets provide for the debt held by its creditors? A highly leveraged firm would be a company with heavy debts in relation to their net worth. These firms are more vulnerable to business downturns than those with lower debt-to-equity positions.

Leverage ratios are the ratios that bankers, creditors and or vendors look at to see “How much of the company does ownership actually own vs its creditors.” Meaning, is the amount of debt you are carrying make you a high risk to grant credit to or a lower risk company?

Debt to Equity

This ratio shows how much debt a company is using relative to shareholder equity. A number greater than one shows the creditors own a larger percentage than the shareholders.

BIG CAVEAT

Balance Sheet equity is a historic concept. It doesn’t consider the value of intangibles such as customer lists which can have significant value or shareholder loans which is treated as debt but if it is a true shareholder loan there is a strong argument that it is really owner’s equity. This is the reason bankers are not attracted to our balance sheets, because our biggest asset (our customer list) is not on it thereby making our leverage ratio’s look poor when in essence our company could be very healthy.

Debt Ratio

Debt ratio is the relation of amount financed to total asset value. An example would be having a $300k mortgage on a house that is purchased for 500K. The debt ratio would be 60%

Equity Ratio

Reciprocal of Debt Ratio showing how much in the way of assets are financed by shareholders.  In the example above the equity ratio would be 40%

Financial Leverage