Leverage or gearing ratios, Financial Accounting

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Leverage or Gearing Ratios - These ratios include the Long Term Debt to Equity Ratio, Total Debt to Equity Ratio, Interest Coverage Ratio. Here, the interest coverage ratio is also called "number of times interest earned". It also includes Equity ratio i.e. Owner's equity to Total Assets. These ratios show the degree of leverage employed by a particular firm in the sense that how much of the total business of a firm is financed by equity, debt etc.

 

Ø  Long Term Debt to Equity Ratio = Long Term Debt / Total Equity

Ø  Total Debt to Equity Ratio = Total Debt / Total Equity

Ø  Interest Coverage Ratio = Earnings before Interest and Taxes (EBIT) / Interest Expense

Ø  Equity Ratio = Owner's Equity to Total Assets

Ø  Fixed Assets to Long term liabilities = Net Fixed Assets to Long Term Liabilities.

Ø  Owner's Equity to Total Liabilities

The Debt to Equity ratios shows the proportion of Debt to the Total Equity in the Company. Interest Coverage Ratio shows the interest paying capability of the company. The higher the ratio, the better is the capability of the company to pay interest on debt outstanding. The higher the equity ratio the lower is the gearing for a firm i.e. to say that the debt is low for that firm and hence the firm has a better position due to fewer obligations. The ratio "Fixed Assets to Long term liabilities", the higher it is the better, because it actually shows how safe are long term creditors in the sense that fixed assets are funded through long term liabilities only.

Tags: The various groups of financial ratios on the grounds of informational homogeneity


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