How this calculator works
The financial leverage ratio divides total assets by total equity. If a company holds $1,000,000 of assets funded by $400,000 of equity and $600,000 of debt, the ratio is 2.5: every dollar of equity supports $2.50 of assets. A higher ratio means more of the asset base is financed by borrowing, which magnifies both gains and losses. The related equity multiplier and debt-to-equity ratio carry the same idea in different units. Leverage is not automatically bad, because debt can lower the cost of capital, but it raises the risk of distress when cash flow falls.
Formula
Financial leverage = total assets / total equity. Total assets = current assets + non-current assets. Equity = total assets / financial leverage.
Worked example
Total assets of $1,000,000 and equity of $400,000 give a leverage ratio of 2.5. If equity fell to $250,000 the ratio would rise to 4.0, showing a much thinner cushion for creditors.
Advertisement
Frequently asked questions
What leverage ratio is safe?
It depends on the industry and the stability of cash flow. Utilities and property companies often carry more debt than software firms. Compare with peers and with the interest coverage ratio rather than applying one threshold everywhere.
How is this different from debt-to-equity?
Debt-to-equity compares debt with equity directly. The financial leverage ratio compares total assets with equity, so it also captures non-debt liabilities such as lease obligations and payables. The leverage ratio equals the equity multiplier used in the DuPont decomposition.
Can the ratio be less than 1?
Only if total equity exceeds total assets, which happens when a company has negative liabilities, an unusual accounting situation. For a normal company with positive liabilities the ratio is at least 1.