This document discusses various leverage ratios that can be used to measure how leveraged or indebted a company is. It defines leverage ratios as ratios that measure how much debt a company is using compared to its equity. It then lists some common leverage ratios including debt-equity ratio, interest coverage ratio, debt service coverage ratio, and debt ratio. For each ratio, it provides the formula and an example calculation to illustrate how to use the ratio. The document emphasizes that leverage ratios indicate a company's ability to repay its long-term debts and service the interest on its debt. Too much debt can make a company riskier and more vulnerable to changes in interest rates.

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Leverage Ratios
Group 2

2. Classification of ratios
Ratios can be broadly classified into 5 groups namely:
1. Liquidity ratios
2. Leverage ratios
3. Turnover ratios
4. Profitability ratios
5. Valuation ratios

3. Leverage ratio
Leverage ratios measure how leveraged a company is.
Highly leveraged means that the company has taken on too many loans
and is in too much debt.
These ratios indicate the long term solvency of a firm and indicate its ability
of the firm to meet its long term commitment to:
1) Repayment of amount on maturity or in predetermined instalments at
due dates and
2) Paying off loans with interest

4. Also a riskier source of finance
1) Companies that are too highly leveraged (that have large amounts of
debt as compared to equity) often find it difficult to grow because of
the high cost of servicing the debt
2) A change in interest rates can have an effect on one’s profit too

5. Leverage
Ratios
1) Debt- equity ratio
2) Interest coverage
ratio
3) Debt service
coverage ratio
4) Debt ratio

6. Debt- equity ratio
1. The Debt-to-Equity ratio (D/E) indicates the proportion of
the company’s assets that are being financed through
debt.
2. This ratio tells us how much loan and equity was used to
purchase assets

7. Terms and Conditions!!!
If a lot of debt is used to finance increased operations, the company could
potentially generate more earnings than it would have without this outside
financing. If this were to increase earnings by a greater amount than the debt
cost (interest), then the shareholders benefit as more earnings are being spread
among the same amount of shareholders. However, the cost of this debt
financing may outweigh the return that the company generates on the debt
through investment and business activities and become too much for the
company to handle. This can lead to bankruptcy, which would leave
shareholders with nothing.

9. Debt- equity ratio= 149,950/171900
= 0.87

10. Analysis
1) Advantage of a very low Debt
equity ratio
2) Paul’s Guitar Shop in progress
3) Capital-intensive industries
tend to have higher debt-to-
equity ratios than low-capital
industries because capital-
intensive industries must
purchase more property,
plants and equipment to
operate

13. Debt- equity ratio=397,785/216159
=1.84

14. Analysis
1) The company has made
equal use of debt and
equity
2) Good for the company
3) Company in progress

15. Debt ratio
Company’s Ability to payoff the loans.
formulas:Debt Ratio:- Total Assets
Total Liabilities
OR
Debt Ratio:- Total Debts
Total Assets

16. Advantages
1) Financial Condition
2) Work Efficiently
3) Future Investment

17. Disadvantages
1) Investors/Lenders
2) Bank Loan
3) High Interest Rate

18. Interest coverage ratio

19. Uses:
1) Interest coverage ratio is also known as Times Interest Earned
2) ICR is a measure of company's ability to meets its interest payment; It
determines how easily a company can pay interest expenses on
outstanding debts
3) It is used to measure company's ability to make its interest payment on
its debt in timely manner

20. Coca cola
ICR= profit before interest and taxes/ Interest
ICR= 8.9/2.1
ICR=4.23
The final answer is 4.23 which indicates that the firm is doing really great.

21. Sarah’s Jam Company
Let’s take a look at an interest coverage ratio example. Sarah’s Jam
Company is a jelly and jam jarring business that cans preservatives and
ships them across the country. Sarah wants to expand her operations, but
she doesn’t have the funds to purchase the canning machines she needs.
Thus, she goes to several banks with her financial statements to try to get
the funding she wants. Sarah’s earnings before interest and taxes is
$50,000 and her interest and taxes are $15,000. The bank would compute
Sarah’s interest coverage ratio like this

22. Formula
ICR= Profit before interest and taxes/ Interest
ICR= $50,000/$15,000
As you can see, Sarah has a ratio of 3.33. This means that has makes 3.33 times
more earnings than her current interest payments. She can well afford to pay the
interest on her current debt along with its principle payments. This is a good sign
because it shows her company risk is low and her operations are producing
enough cash to pay her bills.

24. Debt Service Coverage Ratio
Ratio of cash a business has available for servicing its debts
Allows lenders to know whether or not a business can repay
its potential loan
Calculated by comparing its net earnings with the amount of
its loans & interest payments.

25. Importance
A financial scale a lender uses to determine whether or not
the business produces enough cash flows
In business, unexpected expenses can arise.
Lenders make sure you have extra padding in your bank
account.
Example: machinery break down.

26. Debt service
coverage ratio
Formula
DSCR= Net operating income
Total debt service cost

27. Analysis
When net income = the cost of carrying loans it means your DSCR is 1
It tells you that your business is making just enough money to cover
100% of its current debts, without having a dip into its savings, sell of
assets Or borrowing more money
any ratio value at 1 or just above should be viewed with caution
A slightest reduction in earnings could cause a business to become
financially overextended

28. When a company’s debt service coverage ratio is below 1, it’s
best regarded as an all-out sign of looming financial difficulty.
The debt service coverage ratio measures a company’s ability
to sustain its current level of debt.
The higher the ratio value is, the better its debt servicing
position.
A higher coverage ratio indicates a more positive cash flow & it
also means a business is more likely to pay down its debts in a
timely fashion, since more of its profits from income are
available to put toward loan payments.

29. These ratios measure the
debt obligations for a
company or a firm

30. Thank you