MAFundamentals defines the foundation of Management Accounting from cost concept, classification and analysis. It provides general discussion on COST, VOLUME, PROFIT, VARIANCE and other information necessary for performance measurement, decision making and pricing.

Leverage Ratios

One method of Financial Ratio Analysis, Leverage Ratios measure the company's use of debt to finance its operations and assets.


  • Financial Leverage - also known as trading on the equity, this is the use of debt to finance the company's operations and assets.; It is advisable to trade on equity when earnings from borrowed funds exceed the cost of borrowing.
    • As leverage increases
      • also increases is the risk borne by creditors
      • as well as the risk that the firm may not be able to meet its maturing obligations
    • Leverage increases the company's return when it is profitable due to interest expense being tax deductible
  • Solvency - is known as the firm's ability to pay long-term obligations and long-term survival. Its components are the Capital Structure  and Earning Power.
    1. Capital Structure - the source of financing
      1. Equity (or risk capital) - the ownership interest in the company
      2. Debt - the creditor's interest in the company
    2. Earning Power - the capacity of the company's operation to produce cash inflows

      1. Financial Leverage Ratio (or Equity Multiplier or Leverage Factor)
        FORMULASIGNIFICANCE
        Average Total Assets
        Average Common Equity         		Amount of total assets financed by equity. Higher ratio means higher leverage (assets finances by debt) and also means greater risk.

      2. Financial Leverage Index
        Return on Common Equity
        Return on Assets         		Favorable index exceeds 1.0 and the use of financial leverage is successful.

      3. Interest-bearing Debt Ratio 
        Interest-bearing Debt
        Equity + Interest-bearing debt        		 Measure the extent to which the total capital (asset having explicit cost) are financed by interest-bearing debt.

      4. Total Debt Ratio
        Total Liabilities
        Total Capital Assets        		 Measure the percentage of funds provided by creditors.

      5. Debt to Equity Ratio
        Total Liabilities
        Equity        		 Compares the resources provided by creditors (liabilities) to resources provided by shareholders (equity).

      6. Debt to Tangible Net Worth Ratio
        Total Liabilities
        Equity - Intangible Assets        		 A more conservative way of measuring long-term debt payment ability (than debt ratio or debt to equity ratio).

      7. Times-Interest-Earned Ratio (or Interest Coverage Ratio)
        Earnings before Interest and Tax (EBIT)
        Interest expense        		 Indicates the margin of safety for payment of fixed interest charges.

      8. Fixed Charge Coverage Ratio (or Earnings to Fixed Charges Ratio)
        EBIT + Interest portion of Operating Leases
        Interest + Interest portion of Operating Leases        		 Indicates the margin of safety for payment of all fixed charges

      9. Operating Cash Flow to Total Debt Ratio
        Operating Cash Flow
        Total Debt        		 Measures the portion of total liabilities that can be paid out of the cash flows from operation