Leverage Ratio
How is it calculated?
Leverage Ratio = Total Liabilities / Total Equity
Goal of the Ratio
The goal of this ratio is to measure the proportion of debt to equity financing in a business for easier comparison year over year or customer to customer.
When is it used?
This is a general ratio that can be used in all situations.
Rules of Thumb
Lower is better. As total liabilities increase relative to equity, the amount of risk in a business increases as well, and that shows up through a higher leverage ratio. The higher the ratio the higher the risk, the lower the ratio the lower the risl.
Please note all ratios should be viewed in relation to industry norms to determine overall adequacy.
What changes in the ratio could mean:
Some example reasons why the Leverage Ratio can change:
- Profitable (or unprofitable) operations
- New expansion or purchase financed largely with debt
- Repayment of long term debt
- Building of working capital
- Capital Contributions or Distributions
Other Relevant Terms
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