Financial Leverage Ratio

Luckily, calculating the financial leverage ratio only involves simple division. The main work is sourcing the correct information to plug into the calculator. There are three steps from start to finish. 

1. Add together all current assets (any asset that can be converted into cash within the next 12 months) and non-current assets (any asset that won’t be converted into cash within the 12 months). 
2. Find the total equity listed on the balance sheet.
3. Calculate the financial leverage ratio.

Dovetail Paper is a greeting card company. It has $690,000 in current assets and $3,650,000 in non-current assets. That brings the company’s total assets to $4,340,000.

$4,340,000 = $690,000 + $4,340,000

The total equity listed on Dovetail Paper’s balance sheet is $3,030,000. 

Now we need to divide the total assets of $4,340,000 by the total equity of $3,030,000 to get a financial leverage ratio of 1.43.

1.43 = $4,340,000 / $3,030,000

You can also plug those figures into our calculator to receive your ratio. 

Generally, you want the financial leverage ratio to be as low as possible. A ratio below one is considered ideal for many businesses. But precisely what makes a good ratio depends on the industry, the age of the company, and other factors. The best way to find benchmarks is to calculate the financial ratios of a company’s closest peers and compare them. 

Current assets are things a company owns or possesses that can quickly be converted into cash. This can include cash, cash equivalents, marketable securities, accounts receivable, inventory, prepaid expenses, and non-trade receivables. Current assets are considered short-term resources for companies. 

Non-current assets are things (tangible or intangible) a company owns or possesses that is not easily converted into cash. This could be for several reasons, but the general rule of thumb is anything that takes more than one year to sell counts as a non-current asset. This can include real estate, property plans, manufacturing equipment, office equipment, long-term investments, goodwill, design patents, and intellectual property.

Importantly, businesses can claim depreciation on non-current assets, reducing tax expenses.

Theoretically, if a business has a negative amount of equity (owes more on an asset than it’s worth, for example), it could have a negative financial leverage ratio. Another way to get a negative financial leverage ratio is when the interest rate on a financial obligation rises. This can happen with adjustable interest rate loans ballooning, creating substantial interest payments. In either case, a negative ratio is not a good thing and could mean the company is in or dangerously close to bankruptcy.

Most companies list their total equities on their balance sheet. But for companies not publicly traded or business owners looking to make their financial calculations, there’s another way to find total equity. To do so, simply subtract total liabilities from total assets.

total equity = total assets – total liabilities 

Assets are anything of value, including cash, accounts receivable, equipment, real estate, inventory, tools, and more. Total liabilities are a business’s total debt — all the money owed to another entity (lenders). That can include wages, taxes, loans, accounts payable, and additional obligations.