Financial Leverage Ratio Formula

Financial Leverage Ratio

Financial Leverage = Debt / Equity

Financial leverage is calculated with a purpose of evaluating the company’s capacity to pay its debt. This is easy-to-calculate and monitor financial ratio and it is also called debt-to-equity ratio because it calculates the ratio between the total debt and the total equity.

By looking at this ratio you can easily figure out how much a particular company depends on financing by using debt. You can also use the financial leverage to track and monitor your company’s leverage over time.

Very high value for this ratio means the company might have too much debt and may have potential problems paying back the debt in the future. Total debt on a company’s balance sheet includes both short-term and long-term liabilities, however when it comes to evaluating company’s financial leverage the focus is mainly on long-term liabilities.

The best way to evaluate particular ratio is to compare with the industry averages and competitors. Comparing and benchmarking similar companies make sense while ratios vary across industries and comparing your performance with random companies doesn’t make any sense.

Generally, there are industries with high leverage ratios and there are industries which have lower leverage ratio.

Example for using the formula for calculating financial leverage:

Financial Leverage = Debt / Equity

If a particular company has a debt of $5M and its stakeholders equity has a value of $15M its financial leverage will be:

Financial Leverage = 5 / 15 = 0.33

Is 0.33 a good leverage?

Generally yes, however it depends on the industry and major competitors. Always compare your results with relevant companies.

Keep in mind that while very high leverage may indicate potential issues in the future, very low leverage doesn't necessary mean good performance. Companies with very low financial leverage ratio (compared to others in the industry) may use and take advantage of additional debt to grow faster.