Definition of Leverage Ratio
Leverage ratio is defined as the proportion of debt out of total capital. This in other words tells us the business’s ability to meet its obligations. The leverage ratios are of multiple types.
The most commonly used leverage ratios are:
1. Debt-to-Equity Ratio = Total Liabilities / Total Shareholders’ Equity
This ratio tells us how many times a total debt is of the total equity in a business. The higher this ratio is the more leveraged the business is considered.
2. Debt to total assets ratio = Total Liabilities / Total Assets
Debt to total asset ratio is also a leverage ratio and again tell the percentage of total debt in total assets.
3. Degree of financial leverage = EBIT / (EBIT – Interest)
This ratio shows how leveraged the profits are with respect to interest related to debt. The higher the ratio is means the more vulnerable earnings are.