Financial Leverage Ratio
Find out if investment in a particular company is not too risky!
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If you’re a small business owner, you might need to calculate your business’s financial leverage ratio. However, it can be a complicated calculation for many people.
Don’t fret! With the help of our leverage ratio calculator, you’ll be able to calculate your estimated debts accurately and in no time.
We’ll also tell you all about financial leverage, its formula, and how to calculate it. Let’s dive into the details.
What Is the Financial Leverage Ratio?
Before we calculate the financial leverage, you need to understand how it works first.
A leverage ratio is one of many financial ratios that indicates the level of debt incurred by a company against other accounts. It can also demonstrate the ability of the company to meet its financial obligations.
Typically, a financial leverage ratio measures long-term debt obligations, like one-year or longer financial obligations.
These obligations include the final payment on a debt, any interest payments on the debt, and fixed obligations like lease payments.
Here are some of the most common leverage ratios:
- Debt to EBITDA = Total Debt / EBITDA
- Debt to Equity = Total Debt / Total Equity
- Debt to Capital = Total Debt / (Total Equity + Total Debt)
- Debt to Assets = Total Debt / Total Assets
How Do You Calculate the Financial Leverage Ratio?
The Financial Leverage Ratio formula:
You can calculate the financial leverage of a company by using this formula:
Leverage Ratio = Total Assets / Total Equity
So, you’ll need to calculate total assets and total equity first.
If you find it hard to calculate, you can always use our financial leverage ratio calculator and other helpful tools on CalcoPolis.
You can also check the below example to understand the calculation process.
Example 1
Let’s assume that the following information is about John Doe’s company:
- Current Assets: $1,000,000
- Non-current Assets: $,2,500,000
- Total Equity: $1,000,000
First, we need to calculate the total assets of the company.
Total Assets = Current Assets + Non-current Assets
Therefore:
Total Assets = $1,000,000 + $2,500,000 = $3,500,000
Second, we need to calculate the total equity. In this case, it’s $1,000,000.
Finally, we can calculate the financial leverage ratio.
Financial Leverage Ratio = Total Assets / Total Equity = $3,500,000 / $1,000,000 = 3.5x
Example 2
Let’s take another example of a company using the following financial information:
- Total Assets: $40,000,000
- Total Equity: $20,000,000
- Total Debt: $10,000,000
- Total EBITDA: $5,000,000
Now let’s calculate different leverage ratios:
- Assets to Equity = $40,000,000 / $20,000,000 = 2x
- Debt to Equity = $10,000,000 / $20,000,000 = 0.5x
- Debt to Assets = $10,000,000/ $40,000,000 = 0.25x
- Debt to EBITDA = $10,000,000 / $5,000,000 = 0.5x
What Is a Good Financial Leverage Ratio?
Telling the state of a company’s financial ratio depends on the type of ratio you’re using. In general, many consider a financial leverage ratio of less than 1 to be good.
On the other hand, a leverage ratio higher than one means the company might be at risk of defaulting. Lenders and potential investors usually consider a company with a leverage ratio higher than one to be a risky investment.
Furthermore, a financial leverage ratio higher than two can be a cause for concern. It can lower the credit rating of the company and increase the cost of debt.
However, having high financial leverage can also have its benefits, like increasing the return on investment (ROI) on a certain project.
What Is the Downside to Financial Leverage?
Being highly leveraged can pose a lot of risks to your business. For starters, it can affect current and future cash flow levels.
Additionally, it can have a huge impact on your business finances and your yearly financial projections. You’ll also be risking the possibility of losing money on a purchased asset, as it might lose its value.
How Can This Metric Help You Make Better Decisions?
Any business owner can make use of the financial leverage ratio to undertake a certain investment, expand operations, or start a new project. Companies can use the leverage ratio to finance their assets.
Additionally, investors can use the financial leverage ratio to make a decision on whether or not to invest in a company. On top of that, they can use the leverage to increase the returns that can be provided on their investment.
Conclusion
We hope our leverage ratio calculator will help you with your business finances! Be sure to check out some of the other helpful tools we have on CalcoPolis.
Authors
Created by Lucas Krysiak on 2023-02-16 16:05:53 | Last review by Mike Kozminsky on 2023-02-16 16:18:12