{"id":25530865,"date":"2022-06-29T12:20:55","date_gmt":"2022-06-29T06:50:55","guid":{"rendered":"https:\/\/entri.app\/blog\/?p=25530865"},"modified":"2022-06-30T13:08:04","modified_gmt":"2022-06-30T07:38:04","slug":"leverage-ratio","status":"publish","type":"post","link":"https:\/\/entri.app\/blog\/leverage-ratio\/","title":{"rendered":"Leverage Ratio Definition &#8211; Formula and Calculation"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_79_2 counter-hierarchy ez-toc-counter ez-toc-custom ez-toc-container-direction\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<label for=\"ez-toc-cssicon-toggle-item-69debe44026da\" class=\"ez-toc-cssicon-toggle-label\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/label><input type=\"checkbox\"  id=\"ez-toc-cssicon-toggle-item-69debe44026da\"  aria-label=\"Toggle\" \/><nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/entri.app\/blog\/leverage-ratio\/#Meaning_of_Leverage_Ratio\" >Meaning of \u00a0Leverage Ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/entri.app\/blog\/leverage-ratio\/#Leverage_Ratios_for_Evaluating_Financial_Condition_and_Capital_Structure\" >Leverage Ratios for Evaluating Financial Condition and Capital Structure<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/entri.app\/blog\/leverage-ratio\/#Leverage_Ratio_Quiz\" >Leverage Ratio: Quiz<\/a><\/li><\/ul><\/nav><\/div>\n<p>A leverage ratio\u00a0 is one of several financial measurements that look at how much\u2002capital comes in the form of loans (debt) or assesses the ability of an organisation to meet its financial obligations. The leverage ratio category is significant because organisations rely on a combination of equity and debt to finance their dealings, and knowing the amount of debt held by an organisation is useful in evaluating whether it can pay off its debts as they come due. Several common leverage ratios are discussed in this article.<\/p>\n<p><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-25483248 size-full\" src=\"https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1.png\" alt=\"Stay Updated for Free GK &amp; Current Affairs\" width=\"970\" height=\"250\" srcset=\"https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1.png 970w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-300x77.png 300w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-768x198.png 768w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-750x193.png 750w\" sizes=\"auto, (max-width: 970px) 100vw, 970px\" \/><\/a><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Meaning_of_Leverage_Ratio\"><\/span><strong><b>Meaning of <\/b><\/strong><strong><b>\u00a0Leverage Ratio<\/b><\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Too much debt can be dangerous for an organisation\u00a0and its investors. However, if a company&#8217;s dealings\u00a0can provide a higher rate of return than the interest rate on its debts, then the loan\u00a0may help to fuel growth. Uncontrolled debt levels can cause\u00a0credit downgrades or worse.\u00a0On the other hand, very little\u00a0debts can also raise questions. A hesitancy\u00a0or inability to borrow may be a sign that operating boundaries\u00a0are tight.<\/p>\n<p>There are several types of\u00a0ratios that may be categorized as a leverage ratio, but the main factors taken into consideration\u00a0are debt, assets,\u00a0equity and\u00a0interest expenses.<\/p>\n<p>A leverage ratio may also be used to measure an organisation\u2019s combination of operating expenses to get an idea of how changes in output will affect operating income. Fixed and variable costs are the 2\u00a0types of operating costs; depending on the organisation\u00a0and the industry, the mix will vary.<\/p>\n<p>Lastly, the user\u00a0leverage ratio refers to the level of user\u00a0debt compared to disposable income and is used in economic analysis and by policy-makers.<\/p>\n<h3><strong><b>Banks and Leverage Ratios<\/b><\/strong><\/h3>\n<p>Banks are among the most\u00a0leveraged\u00a0organisations\u00a0in the United States\u00a0of America. The combination of\u00a0fractional-reserve banking\u00a0and\u00a0FDIC or Federal Deposit Insurance Corporation\u00a0protection has produced a banking environment with minimal\u00a0lending risks.<\/p>\n<p>To compensate for this, 3\u00a0distinct regulatory bodies, the FDIC, the\u00a0Federal Reserve,\u00a0and the\u00a0Comptroller of the Currency, review and control\u00a0the leverage ratios\u00a0for American banks.<\/p>\n<p>This means they control\u00a0how much money a bank can lend relative to how much capital the bank provides\u00a0to its own assets. The level of capital is crucial because banks can write down\u00a0the capital portion of their possessions\u00a0if total asset values drop. Assets financed by debt cannot be written down because the bank&#8217;s bondholders and depositors owe\u00a0those funds.<\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n<p>Banking\u00a0regulations for leverage ratios are complex. The Federal Reserve gave guidelines for\u00a0bank holding companies, although these limitations\u00a0change\u00a0depending on the rating assigned to the bank. In general, banks that experience speedy growth or face functional\u00a0or financial difficulties are required to maintain higher leverage ratios.<\/p>\n<p>There are several types\u00a0of\u00a0capital requirements\u00a0and minimum\u00a0reserve placed on American banks through the FDIC and the Comptroller of the Currency that indirectly affects\u00a0leverage ratios. The level of investigation paid to leverage ratios has increased since the Major\u00a0Recession of 2007 to 2009 when banks that were &#8220;too big to fail&#8221; were the main reason\u00a0to make banks more solvent. These limitations\u00a0naturally limit the number of loans made because it is more difficult and more costly\u00a0for a bank to raise capital than it is to borrow funds. Higher capital needs\u00a0can reduce dividends or dilute share value if more\u00a0shares\u00a0are\u00a0given.<\/p>\n<p>For banks, the\u00a0tier 1 leverage ratio is most normally\u00a0used by officials.<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Leverage_Ratios_for_Evaluating_Financial_Condition_and_Capital_Structure\"><\/span><strong><b>Leverage Ratios for Evaluating Financial <\/b><\/strong><strong><b>C<\/b><\/strong><strong><b>ondition and Capital Structure<\/b><\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>The most widely used\u00a0financial leverage ratio is the debt\u00a0to\u00a0equity ratio.<\/p>\n<h3><strong><b>The Debt<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>to<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>Equity <\/b><\/strong><strong><b>or <\/b><\/strong><strong><b>D\/E<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>Ratio<\/b><\/strong><\/h3>\n<p>This is expressed as:<\/p>\n<p>{Debt-to-Equity Ratio} = {Total Liabilities}\/{Total Shareholders&#8217; Equity}<\/p>\n<p>For example, United Parcel Service&#8217;s\u00a0long-term debt for the quarter ending December 2019\u00a0was\u00a0dollar 21.8 billion.<strong><b>\u00a0<\/b><\/strong>Its\u00a0total stockholders&#8217; equity for the ending December 2019 was\u00a0dollar 3.3 billion. The company&#8217;s Dept to Equity or D\/E for the\u00a0quarter was\u00a08.62. It is considered to be very high.<\/p>\n<p>A high debt\u00a0or equity ratio generally\u00a0shows\u00a0that a company has been aggressive in financing its growth with debt. This can cause\u00a0volatile earnings as a result of the additional interest expense. If the firm&#8217;s interest expense grows too high, it may increase the firm&#8217;s chances of a default bankruptcy.<\/p>\n<p>Typically, a D\/E ratio greater than 2.0 signals\u00a0a risky scenario for an investor; however, this yardstick can vary with organisation. Businesses that needs large capital expenditures (CapEx), such as utility and manufacturing firms, may need to take\u00a0more loans than other organisations. It&#8217;s a good thought to measure a firm&#8217;s leverage ratios against previous\u00a0performance and with companies working\u00a0in the same industry to better understand the data. Fedex has a Dept to Equity \u00a0ratio of 1.78, so there is reason\u00a0for concern where UPS is concerned. However, most analysts believe\u00a0that UPS earns enough cash to\u00a0screen\u00a0its debts.<\/p>\n<h3><strong><b>The Equity Multiplier<\/b><\/strong><\/h3>\n<p>The equity multiplier is similar\u00a0to D\/E Ratio, but replaces debt with assets in the numerator:<\/p>\n<p>{Equity Multiplier} = {Total Assets}\/{Total Equity}<\/p>\n<p>For example, assume that Macy&#8217;s (NYSE: M) has assets valued at dollar 19.85 billion and stockholder equity of dollar 4.32 billion. The equity multiplier would be:<\/p>\n<p>{19.85 billion}\/{4.32 \u00a0billion} = 4.59<\/p>\n<p>Although debt is not specifically included\u00a0in the formula, it is an understood\u00a0that the total assets includes debt.<\/p>\n<p>We know\u00a0that\u00a0Total Assets is given by the sum of\u00a0Total Debt \u00a0and Total shareholders&#8217; Equity. The firm&#8217;s high ratio of 4.59 means that assets are mostly funded with loan than equity. From the equity multiplier formula, Macy&#8217;s assets are financed with dollar 15.53 billion in liabilities.<\/p>\n<p>The equity multiplier is a component of the\u00a0<em><i>DuPont analysis<\/i><\/em>\u00a0for calculating \u00a0ROE or return on equity:<\/p>\n<p>\u200bDuPont\u00a0analysis=<em><i>N<\/i><\/em><em><i>PM<\/i><\/em><em><i>\u00a0<\/i><\/em>\u00d7\u00a0<em><i>AT<\/i><\/em>\u00d7\u00a0<em><i>EM<\/i><\/em><em><i>\u00a0<\/i><\/em><\/p>\n<p><strong><b>where: <\/b><\/strong><em><i>NPM<\/i><\/em><em><i>\u00a0<\/i><\/em>=net\u00a0profit\u00a0margin, <em><i>AT<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0asset\u00a0turnover\u00a0and <em><i>EM<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0equity\u00a0multiplier\u200b<\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n<h3><strong><b>The Debt<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>to<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>Capitalization Ratio<\/b><\/strong><\/h3>\n<p>An indicator that gives\u00a0the amount of debt in an organisation\u2019s capital structure is the debt\u00a0to\u00a0capitalization ratio, it gives\u00a0a company\u2019s financial leverage. It is calculated as:<\/p>\n<p>Total\u00a0debt\u00a0to\u00a0capitalization\u00a0=\u00a0(<em><i>SD<\/i><\/em><em><i>\u00a0<\/i><\/em>+\u00a0<em><i>LD<\/i><\/em><em><i>\u00a0<\/i><\/em>+\u00a0<em><i>SE<\/i><\/em>)(<em><i>SD<\/i><\/em><em><i>\u00a0<\/i><\/em>+<em><i>LD<\/i><\/em>)\u200b<\/p>\n<p><strong><b>where: <\/b><\/strong><em><i>SD<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0short-term\u00a0debt, <em><i>LD<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0long-term\u00a0debt\u00a0and <em><i>SE<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0shareholders\u2019\u00a0equity\u200b<\/p>\n<p>In this ratio, operating belongings are capitalized and equity consists of \u00a0both common and preferred shares. Instead of using long-term debt, an analyst may settle\u00a0to use total debt to measure the debt used in a company&#8217;s capital structure. The formula, in this case, would also have the\u00a0minority interest and preferred shares in the denominator.<\/p>\n<h3><strong><b>Degree of Financial Leverage\u00a0<\/b><\/strong><\/h3>\n<p>DFL\u00a0or Degree of financial leverage\u00a0\u00a0is a ratio that provides\u00a0the sensitivity of a firm\u2019s\u00a0EPS or earnings per share\u00a0 to fluctuations in its operating income, as an\u00a0effect\u00a0of changes in its capital structure. It measures the percentage change in earnings per share\u00a0for a unit change in\u00a0EBIT or earnings before interest and taxes\u00a0 and is given by the following formula:<\/p>\n<p><em><i>DFL<\/i><\/em>=%\u00a0change\u00a0in\u00a0<em><i>EBIT<\/i><\/em><em><i>\u00a0and <\/i><\/em>%\u00a0change\u00a0in\u00a0<em><i>EPS<\/i><\/em>\u200b<\/p>\n<p><strong><b>where:<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><em><i>EPS<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0earnings\u00a0per\u00a0share, <em><i>EBIT<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0earnings\u00a0before\u00a0interest\u00a0and\u00a0taxes\u200b<\/p>\n<p>DFL can \u00a0also\u00a0be represented by the equation below:<\/p>\n<p><em><i>DFL<\/i><\/em><em><i>\u00a0<\/i><\/em>=\u00a0<em><i>EBIT<\/i><\/em><em><i>\u00a0<\/i><\/em>\u2212interest <em><i>EBIT<\/i><\/em>\u200b<\/p>\n<p>This ratio\u00a0tells\u00a0that the higher the degree of financial leverage, the more volatile the earnings will be. Since interest is usually a fixed expense, leverage enlarges\u00a0returns and EPS. This is good when operating income is increasing, but it can be a problem when operating income is not that good.<\/p>\n<p style=\"text-align: center\"><a href=\"https:\/\/bit.ly\/3MWTnuS\" target=\"_blank\" rel=\"noopener\"><strong>Grab study materials to strengthen your GK !!! Register Now !!!<\/strong><\/a><\/p>\n<h3><strong><b>The Consumer Leverage Ratio<\/b><\/strong><\/h3>\n<p>The consumer leverage ratio is used to quantify the amount of loan\u00a0the average American user\u00a0has relative to their\u00a0disposable income.<\/p>\n<p>Some economists have said\u00a0that the rapid increase in consumer loan\u00a0levels\u00a0has been a contributing factor to corporate earnings growth over the past few years. Others blamed the high level of consumer loan\u00a0as a major reason\u00a0for\u00a0the\u00a0great recession.<\/p>\n<p>Consumer\u00a0leverage\u00a0ratio\u00a0=\u00a0Disposable\u00a0personal\u00a0income\u00a0\u00a0\/ Total\u00a0household\u00a0debt\u200b<\/p>\n<p>Understanding how debt\u00a0increases returns is the key to understanding leverage. Loan\u00a0is not necessarily a bad thing, particularly if it\u00a0is taken on to invest in projects that will generate positive returns. Leverage can thus multiply returns, even though\u00a0it can also increase losses if returns turn out to be negative.<\/p>\n<h3><strong><b>The Debt<\/b><\/strong><strong><b>\u00a0t<\/b><\/strong><strong><b>o<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>Capital Ratio<\/b><\/strong><\/h3>\n<p>The\u00a0debt-to-capital ratio\u00a0is a measurement of a firm&#8217;s financial leverage. It is one of the more meaningful\u00a0debt ratios\u00a0as\u00a0it focuses on the relationship of debt liabilities as a component of a organisation&#8217;s total capital base. Debt consists of\u00a0all short\u00a0term and long\u00a0term obligations. Capital includes the firm&#8217;s debt and shareholders&#8217; equity.<\/p>\n<p>This ratio is used to understand\u00a0a firm&#8217;s\u00a0financial structure\u00a0and how it is financing operations. Typically, if a firm\u00a0has a high debt\u00a0to\u00a0capital ratio compared to its competitors, it may have a higher\u00a0default risk\u00a0due to the effect the loan\u00a0has on its operations. The oil firm\u00a0seems to have about a 40% debt\u00a0to\u00a0capital threshold. Above that level, debt costs increase significantly.<\/p>\n<h3><strong><b>The\u00a0Debt<\/b><\/strong><strong><b>\u00a0t<\/b><\/strong><strong><b>o<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>EBITDA\u00a0Leverage Ratio<\/b><\/strong><\/h3>\n<p>The\u00a0debt\u00a0to\u00a0EBITDA\u00a0leverage ratio measures a firm&#8217;s ability to pay off its incurred debt. Commonly used by\u00a0credit agencies, this ratio gives\u00a0the probability of defaulting on issued loan. Since oil and gas firms typically have a lot of debt on their balance sheets, this ratio is useful in finding\u00a0how many years of EBITDA would be needed\u00a0to pay back all the debt. Typically, it can be shocking\u00a0if the ratio is over 3, but this can vary depending on the firm.<\/p>\n<h3><strong><b>The Debt<\/b><\/strong><strong><b>\u00a0t<\/b><\/strong><strong><b>o<\/b><\/strong><strong><b>\u00a0<\/b><\/strong><strong><b>EBITDAX\u00a0Ratio<\/b><\/strong><\/h3>\n<p>Another form\u00a0of the debt\u00a0to\u00a0EBITDA ratio is the debt-to\u00a0EBITDAX\u00a0ratio, which is similar, except EBITDAX is EBITDA before exploration costs for\u00a0successful efforts\u00a0firms. This ratio is commonly used in the US\u00a0to normalize different accounting treatments for exploration expenses (the full cost method vs\u00a0the successful efforts method).<\/p>\n<p>Exploration costs are typically found in the\u00a0financial statements\u00a0as abandonment,\u00a0exploration\u00a0and dry hole costs. Other non\u00a0cash expenses that must\u00a0be added back in are \u00a0accretion of\u00a0asset retirement obligations,\u00a0impairments,\u00a0and deferred taxes.<\/p>\n<h3><strong><b>The Interest Coverage Ratio<\/b><\/strong><\/h3>\n<p>Another leverage ratio considered along with interest payments is the\u00a0interest coverage ratio. One problem with only reviewing the total debt liabilities for a firm\u00a0is they do not tell you anything about the firm&#8217;s ability to service the debt. This is exactly what the interest coverage ratio intent to fix.<\/p>\n<p>This ratio, which equals operating income divided by interest expenses, displays\u00a0the firm&#8217;s ability to make interest payments. Generally, a ratio of 3.0 or higher is preferred, although this changes\u00a0from industry to industry.<\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n<h3><strong><b>The Fixed-Charge Coverage Ratio<\/b><\/strong><\/h3>\n<p>TIE or Times interest earned , also\u00a0called the\u00a0fixed-charge coverage ratio, is another form\u00a0of the interest coverage ratio. This leverage ratio tries\u00a0to highlight \u00a0flow\u00a0of cash\u00a0proportionate to interest owed on long-term liabilities.<\/p>\n<p>To calculate this ratio, find the firm&#8217;s\u00a0EBIT or earnings before interest and taxes, then divide by the interest expense of long-term debts. Use pre-tax earnings as\u00a0interest is tax-deductible; the full sum\u00a0of earnings can eventually be used to pay interest. Again, higher numbers are more preferred.<\/p>\n<h3><strong><b>When <\/b><\/strong><strong><b>Does<\/b><\/strong><strong><b>\u00a0Leverage Ratio<\/b><\/strong><strong><b>\u00a0Become<\/b><\/strong><strong><b>\u00a0Useful?<\/b><\/strong><\/h3>\n<p><strong><b>Leverage ratios<\/b><\/strong>\u2014like most financial terms\u00a0used by investors to evaluate firms they are most useful when comparing two or more firms\u00a0within the same industry. Different industries have different norms in terms of loan\u00a0and financing, so comparing the leverage ratio of a bank to that of an manufacturer would not give\u00a0much insight.<\/p>\n<p>Comparing the leverage ratios of two firms\u00a0within the same industry, on the other hand, could provide valuable information about which might be a safer investment. It\u2019s important to note, that the safer investments are\u00a0not\u00a0always better investments. Riskier investments can give\u00a0more considerable returns, but they can also result in bigger\u00a0losses.<\/p>\n<h3><strong>Leverage Ratio Example:<\/strong><\/h3>\n<p>In this\u00a0section \u00a0we use leverage ratios to compare Microsoft and Apple, the 2 large and popular computer firms.<\/p>\n<h4><strong><b>Microsoft vs. Apple<\/b><\/strong><\/h4>\n<p>Comparing the leverage ratios of Microsoft or Nasdaq: MSFT\u00a0and Apple or Nasdaq: AAPL can\u00a0not\u00a0tell us which firm\u00a0is a better investment, nor can it tell us which firm\u2019s stock price has\u00a0a better value. It can, however, tell us how reliant on debt each firm at present\u00a0is to sustain its operations. In times of economic uncertainty\u00a0like recessions\u00a0organisations\u00a0that are less reliant on debt may be safer investments.<\/p>\n<p><strong>Note<\/strong>: The figures below are taken\u00a0from the 2021 financial statements provided by Microsoft and Apple.<\/p>\n<h4><strong>Microsoft Apple<\/strong><\/h4>\n<p>Short-term debt: Dollar 1.96 billion<\/p>\n<p>Short-term debt: Dollar 7.45 billion<\/p>\n<p>Long-term debt: Dollar 71.45 billion<\/p>\n<p>Long-term debt: Dollar 119.38 billion<\/p>\n<p>Shareholders\u2019 equity: Dollar 141.99 billion<\/p>\n<p>Shareholders\u2019 equity: Dollar 63.09 billion<\/p>\n<p>Total assets: 333.78 billion<\/p>\n<p>Total assets: Dollar 351 billion<\/p>\n<h4><strong><b>Microsoft\u2019s Leverage Ratios<\/b><\/strong><\/h4>\n<p><strong>Debt to Equity<\/strong><\/p>\n<p>D\/E = (Short-Term Debt + Long-Term Debt) \/ Shareholders\u2019 Equity<\/p>\n<p>D\/E = (1.96 + 71.45) \/ 141.99<\/p>\n<p>D\/E = 73.41 \/ 141.99<\/p>\n<p>D\/E = 0.517<\/p>\n<p><strong>Debt to Total Assets<\/strong><\/p>\n<p>D\/TA = (Short-Term Debt + Long-Term Debt) \/ Total Assets<\/p>\n<p>D\/TA = (1.96 + 71.45) \/ 333.78<\/p>\n<p>D\/TA = 73.41 \/ 333.78<\/p>\n<p>D\/TA = 0.219<\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n<h4><strong>Apple\u2019s Leverage Ratios<\/strong><\/h4>\n<p><strong>Debt to Equity<\/strong><\/p>\n<p>D\/E = (Short-Term Debt + Long-Term Debt) \/ Shareholders\u2019 Equity<\/p>\n<p>D\/E = (7.45 + 119.38) \/ 63.09<\/p>\n<p>D\/E = 126.83 \/ 63.09<\/p>\n<p>D\/E = 2.01<\/p>\n<p><strong>Debt to Total Assets<\/strong><\/p>\n<p>D\/TA = (Short-Term Debt + Long-Term Debt) \/ Total Assets<\/p>\n<p>D\/TA = (7.45 + 119.38) \/ 351<\/p>\n<p>D\/TA = 126.83 \/ 351<\/p>\n<p>D\/TA = 0.361<\/p>\n<p>From these leverage ratios, it is evident that in \u00a02021, Apple was more debt-reliant than Microsoft.\u00a0Apple\u2019s debt accounted for about two times\u00a0as much of its operations as its equity, whereas Microsoft\u2019s debt accounted for only about half as much of its operations as its equity. About 22% of Microsoft\u2019s total assets were financed by loan, whereas about 36% of Apple\u2019s total assets were financed by loan.<\/p>\n<p>Overall, these calculations\u00a0tell us that Apple is more highly leveraged than Microsoft and as a result may\u00a0be a riskier investment (within the computer industry) during bear markets or recessions.<\/p>\n<h3><strong><b>What <\/b><\/strong><strong><b>do you mean by<\/b><\/strong><strong><b>\u00a0High Leverage Ratio?<\/b><\/strong><\/h3>\n<p>As mentioned above, one firm\u2019s leverage ratios being higher than another\u2019s does\u00a0not \u00a0mean much if the 2\u00a0firms are in different industries, especially if one has been here\u00a0for a lot longer period than the other.<\/p>\n<p>Within an industry, however, if 2\u00a0firms are of similar size and age, and one has\u00a0considerably\u00a0higher leverage ratios, that could indicate that it is a riskier investment, especially during low revenue\u00a0period. In the event that both firms\u00a0have revenue troubles, the one with the higher leverage ratios is more likely to become bankrupt.<\/p>\n<h3><strong><b>What <\/b><\/strong><strong><b>do you mean by<\/b><\/strong><strong><b>\u00a0Low Leverage Ratio ?<\/b><\/strong><\/h3>\n<p>If two firms\u00a0are comparable (in terms of industry, size, and age), but one has considerably\u00a0lower leverage ratios than the other, the less-leveraged firm\u00a0could be considered a safer investment. If both firms\u00a0struggle to achieve revenue, the less-leveraged company is less likely to become bankrupt.<\/p>\n<h3><strong><b>What <\/b><\/strong><strong><b>do you mean by<\/b><\/strong><strong><b>\u00a0Good Leverage Ratio?<\/b><\/strong><\/h3>\n<p>What is considered a \u201cgood\u201d or below average leverage ratio varies significantly with\u00a0industry, as certain types of firms\u00a0are by nature more reliant on debt than others to fund operations. For instance, the average D\/E ratio in the auto firm\u00a0as of January 2022 was about 0.2, while the average for banks was 1.7.<\/p>\n<p style=\"text-align: center\"><a href=\"https:\/\/bit.ly\/3MWTnuS\" target=\"_blank\" rel=\"noopener\"><strong>Grab study materials to strengthen your GK !!! Register Now !!!<\/strong><\/a><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Leverage_Ratio_Quiz\"><\/span><strong><b>Leverage Ratio: Quiz<\/b><\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><strong><b>1. You\u2019ve paid <\/b><\/strong><strong><b>INR <\/b><\/strong><strong><b>25,000 of your <\/b><\/strong><strong><b>INR <\/b><\/strong><strong><b>200,000 house. What is your leverage ratio?\u00a0<\/b><\/strong><\/p>\n<p>a)5<\/p>\n<p>b) 4<\/p>\n<p>c) 7<\/p>\n<p>d) 8<\/p>\n<p><strong><b>Ans (c) 7<\/b><\/strong><\/p>\n<p><strong><b>2. Your home suddenly <\/b><\/strong><strong><b>increases <\/b><\/strong><strong><b>in value. What happens to your owner\u2019s equity?\u00a0<\/b><\/strong><\/p>\n<p>a) It decreases.<\/p>\n<p>b) It increases.<\/p>\n<p>c) The \u00a0value of the house is irrelevant to owner&#8217;s equity.<\/p>\n<p>d) It relies on the change in price level since the home purchase.<\/p>\n<p><strong><b>Ans (b) It increases<\/b><\/strong><\/p>\n<p><strong><b>3. You own a home for which you paid <\/b><\/strong><strong><b>INR <\/b><\/strong><strong><b>10,000 in down <\/b><\/strong><b><\/b><strong><b>payment and have since paid off another <\/b><\/strong><strong><b>INR <\/b><\/strong><strong><b>20,000. Your leverage ratio is 4. If the value of the home falls below ___________, you will be underwater.\u00a0<\/b><\/strong><\/p>\n<p>a) INR 150,000<\/p>\n<p>b) INR 130,000<\/p>\n<p>c) INR 120,000<\/p>\n<p>d) INR 90,000<\/p>\n<p><strong><b>Ans (c) INR 120,000<\/b><\/strong><\/p>\n<p><b><\/b><b><\/b><strong><b>4. If <\/b><\/strong><strong><b>you <\/b><\/strong><strong><b>believe in the basic principle of a risk-reward relationship, <\/b><\/strong><strong><b>your<\/b><\/strong><strong><b>\u00a0conclusion regarding security ratings and yields between an Aaa bond and a Baa bond would be that:<\/b><\/strong><\/p>\n<p>a) there would be lower yield on the Aaa bond.<\/p>\n<p>b) there would \u00a0be higher yield o the Aaa bond.<\/p>\n<p>c) there will lower default risk on the Baa bond.<\/p>\n<p>d) Yields would be equal but default risks would differ.<\/p>\n<p><strong><b>Ans (a) there would be lower yield on the Aaa bond.<\/b><\/strong><\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n<p><b><\/b><strong><b>5. A firm&#8217;s <\/b><\/strong><strong><b>DOL or <\/b><\/strong><strong><b>degree of operating leverage depends primarily upon its<\/b><\/strong><\/p>\n<p>a) sales variability.<\/p>\n<p>b) level of fixed operating costs.<\/p>\n<p>c) closeness to its operating break-even point.<\/p>\n<p>d) debt-to-equity ratio.<\/p>\n<p><strong><b>Ans (c) <\/b><\/strong><strong><b>debt-to-equity ratio.<\/b><\/strong><\/p>\n<p><b><\/b><strong><b>6. An EBIT-EPS indifference analysis chart is used for\u00a0<\/b><\/strong><strong><u><b> \u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0<\/b><\/u><\/strong><\/p>\n<p>a) when effects of buisness is evaluated the EPS is risked.<\/p>\n<p>b) examining EPS leads to alternative financing plans at varying EBIT levels.<\/p>\n<p>c) finding the impact of a change in sales on EBIT.<\/p>\n<p>d) displaying the changes in EPS quality over time.<\/p>\n<p><strong><b>Ans (b)<\/b><\/strong><strong><b>examining EPS <\/b><\/strong><strong><b>leads to<\/b><\/strong><strong><b>\u00a0alternative financing plans at varying EBIT levels.<\/b><\/strong><\/p>\n<p><b><\/b>7. EBIT is generally the same \u00a0as:<\/p>\n<p>a) funds provided by operations.<\/p>\n<p>b) earnings before taxes.<\/p>\n<p>c) net income.<\/p>\n<p>d) operating profit.<\/p>\n<p><strong><b>Ans (d) operating profit.<\/b><\/strong><\/p>\n<p><b><\/b><strong><b>8. In the <\/b><\/strong><strong><b>discour<\/b><\/strong><strong><b>se of operating leverage break-even analysis, if selling price per unit <\/b><\/strong><strong><b>increases<\/b><\/strong><strong><b>and all other variables remain constant, the operating break-even point in units will:<\/b><\/strong><\/p>\n<p>a) fall.<\/p>\n<p>b) rise.<\/p>\n<p>c) stay the same.<\/p>\n<p>d) still be uncertain until interest and preferred dividends paid are known.<\/p>\n<p><strong><b>\u00a0<\/b><\/strong><strong><b>Ans (a) fall<\/b><\/strong><\/p>\n<p><b><\/b><strong><b>9. If <\/b><\/strong><strong><b>an organisation <\/b><\/strong><strong><b>has a DOL of 5 at Q units, this <\/b><\/strong><strong><b>shows <\/b><\/strong><strong><b>us that:<\/b><\/strong><\/p>\n<p>a) EBIT will rise by 5%, if sales rise by 5%.<\/p>\n<p>b) EBIT will rise by 1%, if sales rise by 1%.<\/p>\n<p>c) EBIT will fall by 25%, if sales rise by 5%.<\/p>\n<p>d) EBIT will rise by 5%,if sales rise by 1%.<\/p>\n<p><strong><b>Ans (d)<\/b><\/strong><strong><b>\u00a0EBIT will rise by 5%<\/b><\/strong><strong><b>, <\/b><\/strong><strong><b>if sales rise by 1%.<\/b><\/strong><\/p>\n<p><b><\/b><strong><b>10. The further a firm operates above its operating break-even point, the closer its degree of operating leverage (DOL) measure approaches\u00a0<\/b><\/strong><strong><u><b> \u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0<\/b><\/u><\/strong><\/p>\n<p>a) minus one.<\/p>\n<p>b) zero.<\/p>\n<p>c) one.<\/p>\n<p>d) infinity.<\/p>\n<p><strong><b>Ans (c) one<\/b><\/strong><\/p>\n<p style=\"text-align: center\"><a href=\"https:\/\/bit.ly\/3MWTnuS\" target=\"_blank\" rel=\"noopener\"><strong>Grab study materials to strengthen your GK !!! Register Now !!!<\/strong><\/a><\/p>\n<p><span data-preserver-spaces=\"true\">I hope this article was helpful. The key point to clear an exam lies in methodical and planned preparation. If you are a candidate who wants to pursue your dream career and looking for a good start, our\u00a0\u00a0<\/span><a class=\"editor-rtfLink\" href=\"https:\/\/entri.sng.link\/Bcofz\/od54\/6blp\" target=\"_blank\" rel=\"noopener\"><strong><span data-preserver-spaces=\"true\">Entri app<\/span><\/strong><\/a><span data-preserver-spaces=\"true\"> has got it covered for you. Our team will help you with content and insights related to the topics of your concern. Subscribe to our app today and enrol yourself into various programmes our app offers. Tune in to the app to stay updated regarding various aspects of the subject you are interested in. Feel free to post any queries and doubts in the comment section. We will try our best to reach out. Push away all those self-doubts and negative thoughts. Try to have a clear vision. Ask yourself why you want this. Focus on the good and work hard. 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Good luck.<\/span><\/p>\n<p><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\"><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-25483248 size-full\" src=\"https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1.png\" alt=\"Stay Updated for Free GK &amp; Current Affairs\" width=\"970\" height=\"250\" srcset=\"https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1.png 970w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-300x77.png 300w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-768x198.png 768w, https:\/\/entri.app\/blog\/wp-content\/uploads\/2020\/09\/Stay-Updated-for-GK-Current-Affairs1-750x193.png 750w\" sizes=\"auto, (max-width: 970px) 100vw, 970px\" \/><\/a><\/p>\n<p style=\"text-align: center\"><strong><a href=\"https:\/\/entri.sng.link\/Bcofz\/yv45\/8wer\" target=\"_blank\" rel=\"noopener\">Attempt free GK Mock Test! Download Entri App!<\/a><\/strong><strong><b>\u00a0<\/b><\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"<p>A leverage ratio\u00a0 is one of several financial measurements that look at how much\u2002capital comes in the form of loans (debt) or assesses the ability of an organisation to meet its financial obligations. The leverage ratio category is significant because organisations rely on a combination of equity and debt to finance their dealings, and knowing [&hellip;]<\/p>\n","protected":false},"author":42,"featured_media":25530876,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[802,558],"tags":[],"class_list":["post-25530865","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-articles","category-general-knowledge"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.6 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Leverage Ratio Definition - Formula and Calculation - Entri Blog<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/entri.app\/blog\/leverage-ratio\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Leverage Ratio Definition - Formula and Calculation - Entri Blog\" \/>\n<meta property=\"og:description\" content=\"A leverage ratio\u00a0 is one of several financial measurements that look at how much\u2002capital comes in the form of loans (debt) or assesses the ability of an organisation to meet its financial obligations. 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