What Is Leverage Ratio? | GoCardless

How do you calculate a financial leverage ratio? · Debt / Equity = £15 / £20 = 0.75 · Debt / Assets = £15 / £30 = 0.5 · Debt / Capital = £15 / (£15 + £20) = 0.43. SkiptocontentOpensitenavigationsidebarWhyGoCardless?ForusecaseSubscriptionpaymentsRecurringpaymentsbuiltforsubscriptionsInvoicepaymentsCollectandreconcileinvoicepaymentsautomaticallyCharitiesOptimisesupporterconversionandcollectdonationsOurcustomersCustomerstoriesHearfromourcustomersCustomersuccessOurcustomerfirstapproachCustomerHubTrainingresources,documentation,andmoreForsmallbusinessOverviewImproveyourcashflowKeeptrackofpaymentsReducecostsReducefailedpaymentsIncreaseconversionsForenterpriseOverviewReducechurnReduceinternationalbarriersReduceoperationalcostsReducetimetogetpaidReduceconversionriskProductFeaturesRecurringpaymentsIdealforsubscriptionsandinvoicesInstantBankPayIdealforone-offpaymentsInternationalpaymentsCollectfrom30+countriesSuccess+ReducepaymentfailuresVerifiedMandatesStoppaymentfraudIntegrationsAPIintegrationsBuildacustomintegrationPartnerintegrationsConnectto200+partnerappsPartnersAllPartnersGoCardlessforChargebeeGoCardlessforXeroGoCardlessforZuoraPricingLearnHelp&SupportCustomerHubTrainingresources,documentation,andmoreFAQCommonquestionsansweredAPIdocumentationGuidesforintegratorsNews&resourcesLatestarticlesandresearchGuidetoopenbankingGuidetoDirectDebitTech@GCMasteringPaymentswebinarsLoginSignupBreadcrumbResourcesFinanceWhatisleverageratio?LastEditedNov2020—2minreadTableofcontentsUnderstandingleverageratioWhatisleverage,andhowisitcreated?Whatdoestheleverageratiorepresent?TypesofleverageratioHowdoyoucalculateafinancialleverageratio?Whatrisksareinvolvedwithhighleverage?WecanhelpForbanksandbusinessesalike,leverageratiosareusefulindicatorsofhowtheirassetsarefinanced,whetherthroughdebtorequity.It'salsoausefulmetricformarketanalystsandinvestorstoconsidersinceit'sanassessmentofhoweasilyacompanywillbeabletomeetfinancialobligations.Butwhatisleverageratio?Findouteverythingyouneedtoknow.UnderstandingleverageratioLeverageratioreferstotheproportionofdebtcomparedtoequityorcapital.It'softenusedbybankinginstitutionstotrackfinances.However,businessesalsomakeuseofthisratio.Acompany'sfinancialleverageratioshowsthelevelofdebtincomparisontoitsaccounts,suchastheincomestatement,cashflowstatement,orbalancesheet.Whatisleverage,andhowisitcreated?Companiesrelyonablendofequityanddebttofinancetheiroperations.Leverageiscreatedthroughmanydifferentscenarios,withtheendgoalofobtainingthisfinancing.Hereareafewexamples:Asset-backedlending:Takingondebttopurchasefixedassetslikeproperty,machinery,andequipment.Cashflowloans:Takingondebtbasedonthebusiness'screditworthiness.Thistypeofloanisusuallyonlyavailabletolargercompanies,notstart-ups.Leveragedbuyouts:Privateequityfirmsmighttakeondebttobuyoutthecompany.Financialinstruments:Anindividualmightpurchaseoptions,margins,orsimilarinstruments.Equityinvesting:Investorscanborrowmoneytouseasleverageintheirportfolios.Whatdoestheleverageratiorepresent?Anyinvestorknowsthattoomuchdebtisariskyproposition.Ifacompanycangeneratehigherreturnratesthantheinterestratesandrepaymentsonitsloans,thedebtmightbeausefultoolforgrowth.Leverageratioassessesthislevelofriskbyshowingyoutheproportionofdebttoassetsorcash.Therearealsooperationalleverageratios,whichareseparatefromfinanceleverageratios.Thistypeofformulashowshowchangesinoperationaloutputorexpenseswillimpactincome.Thethirdtypeofleverageratiorelatestoconsumerdebt,whichiscomparedtodisposableincome.Thisisusedtoassesscreditworthinessorinamoreexhaustivefiscalanalysis.TypesofleverageratioWe'vejustgoneoverseveraltypesofleverageratios,primarilyfinancial,operational,andconsumer.Althoughmostofthemfactordebtintotheequation,theothercomponentoftheratiocouldbeequity,capital,orassets.Therefore,theleverageratioformulacouldbewritteninseveralways,dependingonwhat'sbeingcomparedtoyouroutstandingdebtorassets:DebttoEquity=TotalDebt/TotalEquityDebttoAssets=TotalDebt/TotalAssetsDebttoCapital=TotalDebt/(TotalDebt+TotalEquity)AssettoEquity=TotalAssets/TotalEquityHowdoyoucalculateafinancialleverageratio?Tocalculatethistypeofratio,youcanuseoneoftheleverageratioformulasmentionedabove.Forexample,imagineabusinesswiththefollowingfinances:£30millioninassets£15millionindebt£20millioninequityHere'showtocalculatethefinancialleverageratios:Debt/Equity=£15/£20=0.75Debt/Assets=£15/£30=0.5Debt/Capital=£15/(£15+£20)=0.43Whyisthisuseful?Let'stakethedebttoequityratioabove.Thisshowsthatthisbusiness'sratiois0.75,whichindicatesthatequitymakesupmostofitsresources.Whatrisksareinvolvedwithhighleverage?Althoughhighleveragecanpotentiallyleadtogreaterrewards,itcanalsocausegreateruncertaintyorrisk.Ahighfinancialleverageratioindicatesthatthereturnoninvestmentisn'thighenoughtooffsettheinterestpaidondebt.Thisdecreasesoverallprofitability.Highoperatingleverageratiosarealsoproblematic,astheyindicatethecompanyisn'tgeneratingenoughsalesincomparisontoitshighcostsofoperation.Allthesefiguresmustbeexaminedtogethertogainabetterpictureofthebusiness'scurrentfinancialhealth.WecanhelpGoCardlesshelpsyouautomatepaymentcollection,cuttingdownontheamountofadminyourteamneedstodealwithwhenchasinginvoices.FindouthowGoCardless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