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Leverage ratios

Leverage ratios - these ratios are mainly used to evaluate the leverage of different activities in the company. These activities are: debt, equity, assets, operating costs and income. It helps to know the methods of financing in the company and company’s abilities to meet its obligations. Some of the group’s ratios are: debt to equity, debt to assets, net worth, liabilities to equity and so on.

The first of above mentioned ratios - debt to equity, shows how much of short-term and long-term debts are based on the equity of the company. When managers evaluate the debts in the company, they appraise interests as well, so debt to equity ratio is very important for them and for the investors of the company. Higher ratio shows higher leverage of the company. When evaluating the activities in the company, high ratio can show higher risk of it, because it may be that the company has problems to pay interests and debt payments and to acquire more money for further growth.  

Other ratio, like debt to assets, shows the level of the debt in the company comparing to assets and evaluates the risk for the creditors of the company. Higher ratio shows that the company is more risky. We have similar situation with liabilities to assets ratio. Here it shows what part of assets is acquired for borrowed funds. This ratio is important for the creditors and shows how safe their money is. Higher ratio shows lower level of safety in the company and that greater part of company’s activities are financed from borrowed money as opposed to shareholders equity.  When calculating operating leverage, for a company, which has higher fixed costs, it is easier to increase operating revenue compared to companies with high variable costs, because bigger part of costs have already been incurred to fixed ones, so every sale after the breakeven is transferred to the operating income.