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Leverage Ratios

Key Leverage Ratios

Debt-to-Equity

Total debt / shareholders' equity. Capital structure indicator.

Debt-to-EBITDA

Most common in M&A — typical thresholds 4-5× for LBOs.

Interest Coverage

EBIT / interest expense. >3× generally considered healthy.

Debt-to-Assets

Total debt / total assets. Asset-financing perspective.

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Discover the power of leverage ratios, including the debt ratio, debt-to-equity ratio, and interest coverage ratio, and how they can inform your investment decisions by measuring a company's level of debt.

Leverage ratios measure the amount of capital that comes from debt. In other words, leverage financial ratios are used to evaluate a company’s debt levels.

  • Debt ratio measures the relative amount of a company’s assets that are provided from debt

Debt Ratio = Total Liabilities / Total Assets

In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.

  • Debt to equity ratio calculates the weight of total debt and financial liabilities against shareholders’ equity.

Debt to Equity Ratio = Total Liabilities / Shareholder’s Equity

What is a good debt-to-equity ratio? Although it varies from industry to industry, a debt-to-equity ratio of around 2 or 2.5 is generally considered good. This ratio tells us that for every dollar invested in the company, about 66 cents come from debt, while the other 33 cents come from the company's equity.

What counts as a “good” debt-to-equity (D/E) ratio will depend on the nature of the business and its industry. Generally speaking, a D/E ratio below 1.0 would be seen as relatively safe, whereas ratios of 2.0 or higher would be considered risky.

Some industries such as banking, are known for having much higher D/E ratios than others. Note that a D/E ratio that is too low may actually be a negative signal, indicating that the firm is not taking advantage of debt financing to expand and grow.

If a company has a negative D/E ratio, this means that the company has negative shareholder equity. In other words, it means that the company has more liabilities than assets. In most cases, this is considered a very risky sign, indicating that the company may be at risk of bankruptcy.

  • Interest coverage ratio shows how easily a company can pay its interest expenses

Interest Coverage Ratio = Operating Income / Interest Expenses

Generally, an interest coverage ratio of at least two (2) is considered the minimum acceptable amount for a company that has solid, consistent revenues. Analysts prefer to see a coverage ratio of three (3) or better.