Financial Leverage Ratio Analysis

Definition: Financial Leverage Ratio (also called long-term solvency ratio) is used to measure the firm's ability to repay its long-term debts. It gives an indication of the long-term solvency of the firm.

Formula:
1) Debt to Equity = Total Debt / Total Equity
2) Total Debts to Assets = Total Liabilities / Total Assets
3) Interest Coverage Ratio = Earnings Before Interest and Taxes / Interest Charges
4) Debt service coverage ratio = Net Operating Income / Total Debt Service
5) Capitalization Ratio = Long-term Debt / (Long-term debt + Shareholder equity)

Learn how to calculate financial leverage ratio with the following examples:

Example 1:
CK Ltd has total liabilities of $700,000 and total stockholders' equity of $380,000, then the debt/capital ratio is: 700,000 / (700,000 + 380,000) = 700,000 / 1,080,000 = 0.6481 = 64.81%

Example 2:
Saint Ltd. is looking at an investment property with a net operating income of $87,000 and an annual debt service of $58,000. The debt service coverage ratio for this property = 87,000 / 58,000 = 1.5

Example 3:
Jimmy plc has total sales revenue of $99,000 for the year. It has cost sales $9,000 and operating expenses of $5,000. The company's interest expense for the year is $25,000.
Then,
Earnings Before Interest and Taxes = Sales – Cost of sales – Operating expenses
EBIT = $99,000 - $9,000 - $5,000
EBIT = $85,000
Interest Coverage Ratio = $85,000/$25,000 = 3.4 times

Example 4:
Peters Ltd has the following information:
Creditors $2,000
Loan $38,000
Buildings $60,500
Debtors $7,000
Bank $5,000
Stocks $4,500

Then, the Total Liabilities = 2,000 + 38,000 = $40,000
Total Assets = 60,500 + 7,000 + 5,000 + 4,500 = $77,000
Total Debts to Assets = 40,000 / 77,000 = 0.519

* Featured Articles:

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Kelvin Wong Loke Yuen is an experienced writer with a strong background in finance, specializing in the creation of informative and engaging content on topics such as investment strategies, financial ratio analysis, and more. With years of experience in both financial writing and education, Kelvin is adept at translating complex financial concepts into clear, accessible language for a wide range of audiences. Follow him on: LinkedIn.

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