Leverage Ratios

LEVERAGE RATIOS

Leverage ratios refers to the use of debt finance.  The long term solvency of a firm can be examined by using the leverage ratio’s and these ratios helps in assessing the risk arising from the sue of debt capital (creditors owners and management).

The principal leverage ratios are

1. Debt Equity Ratios
2. Proprietary Ratios

1.       Debt Equity Ratios
This ratio measures the long term financial solvency of a firm this ratios reflects the relatives claims of creditors and share holders against the assets of the firm debt refers to long term.  Liability and equity means owners or proprietors funds.  The standard ratio is 2:1.

Debt Ratio =        Debt/Equity

2.       Proprietary Ratios

The proprietary ratio is an index of the amount of proprietary funds invested on the total assets of a concern.  It also indicates the proportion between owned capital and loaned capital.  It indicates the relative risks of the owner and creditors.

Proprietary Ratio =      Net Worth/ Total Assets

Net worth means the excess of total assets over total liabilities.  Total assets refers to all reliable assets (Does not include goodwill) Generally ratio is 5:1 considered ideal.