A company's leverage ratio indicates how much of its assets are paid for with borrowed money. A higher ratio means that more of the company's assets are paid for with debt. For example, a leverage ratio of 2:1 means that for every $1 of shareholders' equity the company owes $2 in debt. High debt can hamstring a company's cash flow because of large interest payments and limit its ability to borrow more money. However, interest paid on debt may be tax-deductible and allow the company to take advantage of opportunities it might not otherwise be able to afford.
Look up the company's total debt and total stockholders' equity in its annual report. The total debt includes both short-term and long-term debt liability. The shareholder's equity can be calculated by multiplying the number of shares outstanding by the price per share.
Divide the company's total debt by the shareholders' equity. For example, if the company has $2 million in debt and $3 million in shareholders' equity, divide $2 million by $3 million to get 1.5.
Replace "A" with the result in the ratio A:1. In this example, replace A with 1.5 to find that leverage ratio for the company is 1.5:1. This means that the company owes $1.50 in debt for every $1 of stockholders' equity.
- George Doyle/Stockbyte/Getty Images
- How to Calculate Equity Return
- How to Find the Turnover Ratio on an Annual Report
- How to Calculate Diluted Shares from Options
- How to Calculate an Equity Multiple
- How to Calculate the Weighted Average Beta of the Stocks Within the Portfolio
- What Industry Typically Has the Highest Debt-to-Equity Ratios?
- How to Find Earnings Available for Common Stockholders
- Debt-Equity Ratio & Total Debt Ratio