### 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

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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

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Interest Coverage Ratio Example

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