gold stocks postpage LB desk

Understanding Types Of Leverage Ratios

  • February 16, 2019 09:15 AM AEDT
  • Team Kalkine
Understanding Types Of Leverage Ratios

A leverage ratio measures the proportion of capital in the capital structure of the company that is contributed in the form of debt or loans or assesses the ability of a company to meet its financial obligations. It is of paramount importance for the companies since the capital structure of a company is generally funded by a mix of equity and debt, and the company must evaluate and have an idea whether it can pay off its debts as they are due, without posing much threat or difficulties to the regular ongoing operations.

non AMP MTF 10th feb webinar

Relying on heavy debts can be risky for a company and its investors. However, if a company can generate a higher rate of return than the interest rate, then resorting to debt could be beneficial, since it can add to the growth of the profits. The proportion of debt and equity is significant to find an optimum capital structure of the company to determine the cost of funds.

There are several different specific ratios that may be classified as a leverage ratio, however, below are few detailed leverage ratios:

Debt-to-Equity: The debt to equity ratio is the most common leverage ratio, calculated by dividing total liabilities by shareholders equity. Generally, long-term debts which are Interest-bearing in nature are considered as the liabilities in the calculation. The ratio indicates the mix of equity and debt used to finance the assets. A lower DE ratio is considered as good from risk perspective as too much debt obligations exposes the company to default in case of failures. Even lenders are reluctant to offer loans to highly leveraged firms. Besides, an extremely low DE ratio is not preferable by investors with company not financing expansion and diversification plans from borrowing.

Debt-to-Capital: The debt-to-capital ratio measures the financial leverage of the company. Here debt includes all short-term and long-term obligations whereas capital includes the company's debt and shareholder's equity. The ratio is used to evaluate the financial structure of the company and how it is financing its operations. A high debt-to-capital ratio may indicate a higher risk of default by the company compared with its peers.

Debt-to-EBITDA: The Debt-to-EBITDA ratio is usually used by the credit rating agencies, which determines the probability of defaulting on debt issued by the company. It is a measurement of whether a company can pay off its debts and also determine how many years of EBITDA would be necessary to repay all the debts especially for companies with huge debts on their balance sheets. An example may be oil & gas companies. The ratio varies depending on the industry however anything above 3 is very high. Another variation of this ratio is Debt/EBITDAX where EBITDAX is EBITDA before exploration costs.

Equity Multiplier or Total Asset-to-Equity: The formula for the ratio is company's total asset value/ total net equity. Total Asset-to-Equity measures the financial leverage of the company. Higher equity multiplier suggests that the company has financed a larger portion of its asset using debt.

Interest Coverage Ratio: The interest coverage ratio, as the name suggests, whether a firm can meet or cover the interest payments on its outstanding debts. The formula used is EBIT/Interest Expense. A higher ratio indicates a lesser risk to the lender. A multiple higher than 1 is considered very healthy generally.

The above leverage ratios are mainly used by the analysts; however, there can be several other leverage ratios that the analyst might use as per requirement. In any of the circumstances, these ratios must be viewed in conjunction with other valuation metrics and factors of the company for better understanding and valuation.


This website is a service of Kalkine Media Pty. Ltd. A.C.N. 629 651 672. The website has been prepared for informational purposes only and is not intended to be used as a complete source of information on any particular company. Kalkine Media does not in any way endorse or recommend individuals, products or services that may be discussed on this site. Our publications are NOT a solicitation or recommendation to buy, sell or hold. We are neither licensed nor qualified to provide investment advice.



The website is a service of Kalkine Media Pty. Ltd. (Kalkine Media) A.C.N. 629 651 672. The principal purpose of the content on this website is to provide factual information only and does not contain or imply any recommendation or opinion intended to influence your financial decisions and must not be relied upon by you as such. Some of the content on this website may be sponsored/non-sponsored, as applicable, but is NOT a solicitation or recommendation to buy, sell or hold the stock of the company (or companies) or engage in any investment activity under discussion. We are neither licensed nor qualified to provide investment advice through this platform. In providing you with the content on this website, we have not considered your objectives, financial situation or needs. You should make your own enquiries and obtain your own independent advice prior to making any financial decisions.
Some of the images that may be used on this website are copyright to their respective owner(s). Kalkine Media does not claim ownership of any of the pictures displayed on this website unless stated otherwise. The images that may be used on this website are taken from various sources on the web and are believed to be in public domain. We have used reasonable efforts to accredit the source (public domain/CC0 status) to where it was found and indicated it below the image. The information provided on the website is in good faith, however Kalkine Media does not make any representation or warranty regarding the content, accuracy, or use of the content on the website.


We use cookies to ensure that we give you the best experience on our website. If you continue to use this site we will assume that you are happy with it. OK