Concept And Types Of Leverage Ratios

Leverage ratios are also called long-term solvency ratios or capital structure ratios. The term 'solvency' implies the ability of a company to meet the payments associated with its long-term debts. Thus solvency ratios are the measure of the company's ability to meet its long-term obligations. Generally, leverage ratios are expressed in proportions. However, if the ratio is in fraction or less than one, it is expressed in percentage.

The following are the major types of leverage ratios:

1. Debt-equity Ratio
2. Debt to total capital ratio

1. Debt-Equity Ratio
Debt-equity ratio is calculated to ascertain the soundness of the company's long-term financial position. Debt-equity ratio indicates the extend to which it depends upon borrowed funds for its existence. It portrays the proportion of its total funds acquired by way of external financing.
The debt-equity ratio is ascertained by using the following formula:

Debt-Equity Ratio = Long term debt/Shareholders' fund
Or
Debt-Equity Ratio = Total debt/Total shareholders fund

Long-term debt
The debt which is payable after current year is called long term debt. Long term debt include term loans,debentures, bonds, mortgage loans and secured loans.

Total debt
Total debt includes both short term and long term debt. Short term debts are the current liabilities.

Shareholders' Fund
Shareholders' fund is also known as net worth or shareholders' equity.It is the amount which belongs to the company's shareholders of owners.

2. Debt To Total Capital Ratio
Debt to total capital ratio shows the relationship between long term debt and total capital employed by the company. Total capital includes long term liabilities plus shareholders' equity. Total capital is also regarded as permanent capital or capital employed or long term fund. Debt to total capital ratio is ascertained by using the following formula.

Debt to total capital ratio = Long term debt/Total capital Or, Total debt/Total capital

* Total Debt = Long term debt+Current liabilities
* Total Capital = Long term debt+Shareholder's fund