# Financial Leverage Ratios to Measure Business Solvency

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Financial leverage ratios are also called "debt ratios," and they measure the ability of the business to meet its long-term (one year or longer) debt obligations. Those obligations include interest payments on debt, the final principal payment on the debt, and any other fixed obligations like lease payments.

These ratios compare the overall debt load of a company to its assets or equity, showing how much of the company's assets belong to shareholders and creditors. If shareholders own more assets, the company is said to be less leveraged. If creditors own a majority of assets, the company is said to be highly leveraged. Financial leverage ratios help management and investors understand ​the risk level of the capital structure of a company.​​​

### Key Takeaways

• Using financial leverage ratios helps management and potential investors understand one part of a business's risk.
• You can calculate a company's debt ratio by dividing its debt by its assets.
• Figuring out the debt-to-equity ratio requires diving a business's debt by its equity.
• The equity ratio is found by dividing all assets on the balance sheet by the company's equity.
• To determine a company's financial standing, you should use financial leverage ratios in conjunction with trend analysis and other data points.

## Debt Ratio

A company's debt ratio (or "debt-to-asset" ratio) measures its total liabilities against its total assets. The ratio is expressed as a percentage. It implies the company's ability to satisfy its liabilities with its assets, or how many assets the company must sell to pay all its liabilities. It shows the company's overall debt burden.

### Note

The debt ratio is calculated by dividing total debt by total assets. Both of these numbers can easily be found on the balance sheet.

A ratio of 0.5% or less is seen as favorable, indicating stability and longevity. A ratio of 1 means that total liabilities equals total assets. In other words, the company would have to sell off all of its assets in order to pay off its liabilities.

## Debt-to-Equity Ratio

The debt-to-equity ratio compares a company's total debt to total equity, indicating the percentage of company financing that comes from creditors and investors. A higher debt-to-equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders

### Note

The debt-to-equity ratio is calculated by dividing total debt by total equity.

The debt-to-equity ratio is considered a balance sheet ratio because all of the elements are reported on the balance sheet. A debt-to-equity ratio of 1 would mean that investors and creditors have an equal stake in the business assets. A lower debt-to-equity ratio usually implies a more financially stable business.

## Equity Ratio

The equity ratio measures the value of assets that are financed by owners' investments by comparing the total equity in the company to the total assets. In other words, after all of the liabilities are paid off, how much of the remaining assets the investors will end up with. The equity ratio also measures how much of a firm's assets were financed by investors, or the investors' stake in the company.

### Note

The equity ratio is calculated by dividing total equity by total assets. All of the assets and equity reported on the balance sheet are included in the equity ratio calculation.

A higher equity ratio is seen as favorable because it shows that investors have confidence and are willing to back this company and that the company is more sustainable and less risky

### The Bottom Line

These financial leverage ratios allow the owner of the business to determine how well the business can meet its long-term debt obligations. These ratios aren't worth much by themselves, though. You have to be able to do trend and industry analysis to be able to determine how well you are managing your debt position.

## What are financial leverage ratios?

Financial leverage ratios are a series of calculations you can use to judge the percentage of debt and equity a company has compared to other important metrics such as assets.

## What are three ways of measuring financial leverage?

Three popular leverage ratios include the debt ratio, debt-to-equity ratio, and equity ratio. A debt ratio of 0.5% or less is considered favorable.