The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their business activities and operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay its debts off as they fall due.
- leverage ratios measure how much debt a company has relative to its capital. A company’s degree of leverage is one tool used to measure the risk of loans and its cost of borrowing.
- when the debt ratio is high, for example, the company has a lot of debt relative to its equity, the company is carrying a bigger burden due to the principal and interest payments take a significant amount of the company’s cash flows, and any obstacles in financial performance of the company or an increase in interest rates could result in default.
- when the debt ratio is low, principal and interest payments do not command such a large portion of the company’s cash flow and the company is not as sensitive to changes in business performance or interest rates. However, a low debt ratio can also indicate that the company has an opportunity to use leverage to increase borrowing as a means to grow the business.
- in general, a high debt-to-equity ratio indicates that a company may struggle to generate enough cash to satisfy its debt obligations. However, low debt-to-equity ratios may also indicate that a company is not taking advantage of the increased profits that financial leverage may bring.
Our expert team at Francis Wilks & Jones are here to help you with any clarifications that you may require in relation to leverage ratio. Our knowledge of ratio is very broad and we have dealt with many enquiries on leverage loans and leverage ratio. Our practical daily experience and legal expertise means that we can assist whatever the nature of your enquiry.
