Leverage Ratios are a valuable family of financial ratios that business owners should understand how to calculate and analyze when running their business.
What are Leverage ratios?
Leverage ratios are formulas that put two numbers from your business’ Balance Sheet and/or Income Statement in contrast with one another, in order to create a helpful financial ratio.
This family of financial ratios looks at how the capital structure of your business is balanced between debt and assets. Certain leverage ratios also help assess a company’s ability to pay its loans.
Balance Sheet: A core financial statement that records a snapshot of a company’s assets, liabilities, and equity at the time of publication. For more information about the Balance Sheet, read our helpful blog post !
Income Statement: Another core financial statement that reports a company’s revenue and expenses over a set period of time.
Which Leverage Ratios have individual videos?
To help you thoroughly understand Leverage Ratios, Know Your Numbers Accounting has created videos explaining each of the following:
Debt ratio – Measures the use of debt to finance a company
Equity ratio – Measures the use of equity to finance a company
Debt-to-equity ratio – Measures the use of debt and owner funds to finance a company
Interest coverage ratio – Measures a business’s ability to use debt effectively
What can Leverage Ratios tell me about my business?
Leverage Ratios are a useful tool when analyzing the capital structure of your business. All companies function on a financial foundation that is a mix between debt and equity/assets. Depending on the Leverage Ratio, the equation will provide you with a number that indicates how your mix of capital may affect your ability to meet your financial obligations and remain solvent.
Leverage ratios are also used by lenders to figure out whether or not to extend credit or loans to a business. Leverage Ratios such as the Interest Coverage Ratio and Debt to Equity Ratio are frequently used to determine a company’s level of risk. A company with a lower level of risk and greater solvency is much more likely to be approved for additional loans.