## Leverage Ratios — I. Capital Structure Ratios
Leverage ratios measure the long-term stability and capital structure of a firm — the mix of funds provided by owners vs lenders. They assure long-term lenders about (i) periodic interest payment and (ii) repayment of principal on maturity.
Leverage ratios split into Capital Structure ratios (shown here) and Coverage ratios (separate topic). Capital structure ratios reveal the relative weight of each source of funds — something the absolute balance sheet figures alone don't show.
### A. Equity Ratio
$$\text{Equity Ratio} = \frac{\text{Shareholder's Equity}}{\text{Net Assets}}$$
- Shareholder's Equity = Equity Share Capital + Reserves & Surplus (excluding fictitious assets).
- Net Assets / Capital Employed = Net Fixed Assets + Net Current Assets (CA − CL).
- Higher owner's proportion → lower risk for lenders.
### B. Debt Ratio
$$\text{Debt Ratio} = \frac{\text{Total Debt}}{\text{Net Assets}}$$
- Total Debt = all outside liabilities: short- & long-term borrowings, debentures/bonds, deferred payment arrangements, bank borrowings, public deposits, any interest-bearing loan.
- A ratio > 1 means most assets are debt-funded — risky.
### C. Debt to Equity Ratio
$$\text{D/E} = \frac{\text{Total Debt*}}{\text{Shareholder's Equity}} \quad\text{or}\quad \frac{\text{Long-term Debt**}}{\text{Shareholders' Equity}}$$
- *Total Debt = both current & non-current liabilities (not merely long-term).
- **Sometimes only long-term debt is used (excluding current liabilities).
- High D/E → less protection for creditors; low D/E → wider safety cushion. It is the indicator of financial leverage and drives capital-structure decisions (shares vs debentures).
### D. Debt to Total Assets Ratio
$$= \frac{\text{Total Debt}}{\text{Total Assets}}$$
- Proportion of assets financed by debt; higher → higher financial leverage, less equity backing.
### E. Capital Gearing Ratio
$$\text{Capital Gearing} = \frac{\text{Pref. Share Capital} + \text{Debentures} + \text{Other Borrowed Funds}}{\text{Equity Share Capital} + \text{Reserves \& Surplus} - \text{Losses}}$$
- Proportion of fixed interest/dividend-bearing capital to equity (net worth). Higher → more risk (highly geared).
### F. Proprietary Ratio
$$= \frac{\text{Proprietary Fund}}{\text{Total Assets}}$$
- Proportion of total assets financed by shareholders; higher → less risky.