Determining Debt and Leverage Ratios
This calculator can be used to determine several fundamental debt and leverage ratios from information on the balance sheet and income statement. The calculator needs a total of five inputs, including:
- The total assets of the company, as found on the balance sheet
- The company’s total liabilities, as found on the balance sheet
- The balance in Owner’s Equity, as found on the balance sheet
- The company’s operating income, as found on the income statement
- The company’s interest expense, as found on the income statement
The calculator then provides the user with four outputs, including:
- The company’s debt ratio, which are the company’s liabilities divided by its assets
- The company’s debt-to-equity ratio, which is found by dividing owner’s equity by liabilities
- The company’s equity multiplier, which is found by dividing assets by owner’s equity
- The company’s interest coverage ratio, which is found by dividing interest expense by operating income
Also known as accounting ratios, financial ratios are used by analysts and investors to benchmark the performance of an organization. Typically, two or more numerical values are taken from a company’s financial statements, which includes the income statement, balance sheet, statement of retained earnings, or cash flow statement. Analysts will then calculate various ratios to compare the performance of one company to its peer group.
Debt and Leverage Ratios
This calculator can be used to figure out four debt and leverage ratios taking information from both the balance sheet and income statement. A debt ratio measures the amount of debt a company is using to finance their operations. They are usually studied to decide if a company will be able to repay the debt owed lenders. Leverage ratios are similar to debt ratios, since they measure how much capital funding comes from debt. Using just five numerical values from a company’s income and balance sheet, this calculator can determine four of these ratios:
- Debt Ratio: This metric is found by dividing liabilities by assets. When the ratio is greater than one, a higher proportion of the company’s debt will be funded by assets. When the ratio is lower than one, a higher proportion of the company’s debt will be funded by equity. During times of rising interest rates, a company with a high debt ratio may have trouble paying the interest due on their bonds or loans.
- Debt-to-Equity: One of the more closely watched ratios by analysts and creditors since the measure reveals management’s desire to fund growth through debt rather than equity. Creditors are concerned about this metric since high ratios of debt to equity put the repayment of their loans at risk.
- Equity Multiplier: This value is found by dividing total assets by owner’s equity. Lower values are seen as a positive since it means the company is avoiding debt to finance assets and is issuing stock to finance growth.
- Interest Coverage: Also referred to as times interest earned, interest coverage allows analysts to understand the company’s ability to pay its interest expense using income generated by operations. Generally, it’s desirable to have an interest coverage ratio of 3.0 or higher.
Interpreting the Results of Our Calculator
While it is possible to draw some conclusions about the financial health of a company just by examining its debt and leverage ratios, a much better approach is to compare a company’s results to its peer group. Different industries experience different rates of growth, and that variation may be reflected in its ratios. Whenever possible, think about how a company is positioned in terms of growth and how that might also influence its financial ratios in the near term.