This document discusses various leverage ratios used in ratio analysis of financial statements. It defines leverage ratios as ratios that evaluate a company's ability to pay off debt obligations. Several leverage ratios are defined, including proprietary ratio, equity to fixed assets ratio, equity to current assets ratio, current liabilities to shareholders' funds ratio, debt equity ratio, and capital gearing ratio. Formulas for calculating each ratio are provided along with interpretations of the ratios. Examples are included to demonstrate calculating some of the leverage ratios.

1. MANAGEMENT ACCOUNTING
RATIO ANALYSIS
BY:
SMT.UMA MINAJIGI REUR
HEAD, DEPT. OF COMMERCE & MANAGEMENT
SMT. V G DEGREE COLLEGE FOR WOMEN, KALABURAGI

2. MANAGEMENT ACCOUNTING
RATIO ANALYSIS
LEVERAGE RATIOS - 1

3. An analysis of financial statements with the help of ratio is called Ratio
Analysis.
Ratio refers to Numerical or Quantitative relationship between two items.
What are Financial Ratios?
Financial ratios are created with the use of numerical values taken from financial
statements to gain meaningful information about a company. The numbers found
on a company’s financial statements – balance sheet, income statement, and cash
flow statement – are used to perform quantitative analysis and assess a
company’s liquidity, leverage, growth, margins, profitability, rates of return,
valuation, and more.

4. Ratio analysis is a process used for the calculation of financial ratios or in
other words, for the purpose of evaluating the financial wellbeing of a
company. The values used for the calculation of financial ratios of a company
are extracted from the financial statements of that same company.
Ratio analysis can be defined as the process of ascertaining the financial ratios
that are used for indicating the ongoing financial performance of a company
using few types of ratios such as liquidity, profitability, activity, debt, market,
solvency, efficiency, and coverage ratios and few examples of such ratios are
return on equity, current ratio, quick ratio, dividend payout ratio, debt-equity
ratio, and so on.

5. Classification of Accounting Ratio
Types of ratios are given below:
1. Liquidity Ratios
2. Leverage Ratio
3. Turnover Ratio
4. Profitability Ratio

6. 1. Leverage Ratios or Solvency Ratios or Capital Structure Ratios
Leverage or Solvency ratios can be defined as a type of ratio that is used to evaluate
whether a company is solvent and well capable of paying off its debt obligations or
not. These ratios are used to measure the long term financial position as a test of
solvency of an organisation.
The types of Leverage ratios are: –
1. Proprietary Ratio or Equity Ratio
2. Equity to Fixed Asset Ratio
3. Equity to Current Assets Ratio
4. Current Liabilities to Shareholders Funds Ratio
5. Debt Equity Ratio
6. Capital Gearing or Leverage Ratio

7. 1. Proprietary Ratio or Equity Ratio or Total Assets Ratio: The ratio establishes the
relationship between shareholder’s funds and total assets of a firm.
Shareholder’s Funds:
Paid-up equity capital
Preference Share Capital
Reserves
Profit & Loss (Credit Balance)
Total Assets : Fixed Assets + Current Assets
Proprietary 𝑹𝒂𝒕𝒊𝒐 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′𝒔 𝑭𝒖𝒏𝒅𝒔
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Interpretation:
Standard Ratio is 5:1
If ratio is high it indicates strong in financial position.
If ratio is low it indicates weak in financial position.

8. 1. From the following information calculate the proprietary ratio:
Equity Share capital 3,00,000 Fixed Assets 3,57,000
Preference Share Capital 1,50,000 Current Assets 1,50,000
Reserves 75,000 Investments 2,25,000
Debentures 1,80,000
Creditors 45,000
7,50,000 7,50,000
Proprietary 𝑹𝒂𝒕𝒊𝒐 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′𝒔 𝑭𝒖𝒏𝒅𝒔
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔

9. 1. From the following information calculate the proprietary ratio:
Equity Share capital 3,00,000 Fixed Assets 3,57,000
Preference Share Capital 1,50,000 Current Assets 1,50,000
Reserves 75,000 Investments 2,25,000
Debentures 1,80,000
Creditors 45,000
7,50,000 7,50,000
Solution:
1) Calculation of Shareholder’s Funds: 2) Calculation of Total Assets:
Equity Share capital 3,00,000 Fixed Assets 3,57,000
Preference Share Capital 1,50,000 Current Assets 1,50,000
Reserves 75,000 Investments 2,25,000
5,25,000 7,50,000
Calculation of Total Funds:
Equity Share capital 3,00,000
Preference Share Capital 1,50,000
Reserves 75,000
Debentures 1,80,000
7,05,000

10. Solution:
1) Calculation of Shareholder’s Funds: 2) Calculation of Total Assets:
Equity Share capital 3,00,000 Fixed Assets 3,57,000
Preference Share Capital 1,50,000 Current Assets 1,50,000
Reserves 75,000 Investments 2,25,000
5,25,000 7,50,000
Proprietary 𝑹𝒂𝒕𝒊𝒐 =
𝑺𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓′𝒔 𝑭𝒖𝒏𝒅𝒔
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
Proprietary 𝐑𝐚𝐭𝐢𝐨 =
𝟓,𝟐𝟓,𝟎𝟎𝟎
𝟕,𝟓𝟎,𝟎𝟎𝟎
Proprietary 𝐑𝐚𝐭𝐢𝐨 = 𝟎. 𝟕 ∶ 𝟏

11. 2. Equity to Fixed Assets Ratio: The ratio establishes the relationship between Net fixed assets
of the firm and Owner’s finds.
Shareholder’s Funds or Owner’s Equity:
Paid-up equity capital
Preference Share Capital
Reserves
Profit & Loss (Credit Balance)
Fixed Assets
Equity to Fixed Assets Ratio =
𝑭𝒊𝒙𝒆𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
𝑶𝒘𝒏𝒆𝒓′𝒔 𝑬𝒒𝒖𝒊𝒕𝒚
∗ 𝟏𝟎𝟎
Interpretation:
Standard Ratio is 2/3 or 67%
If ratio is high it indicates strong in financial position.
If ratio is low it indicates weak in financial position.

12. 3. Equity to Current Assets Ratio: The ratio establishes the relationship between current assets
of the firm and Shareholder’s finds. (Current Assets to Shareholders Funds )
Shareholder’s Funds or Owner’s Equity:
Paid-up equity capital
Preference Share Capital
Reserves
Profit & Loss (Credit Balance)
Current Assets
Equity to Current Assets Ratio =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
Shareholders Funds
Interpretation:
No Standard Ratio
If ratio is high it indicates strong in financial position.
If ratio is low it indicates weak in financial position.

13. 4. Current Liabilities to Shareholders’ funds Ratio: The ratio establishes the relationship
between current liabilities of the firm and Shareholder’s finds.
Shareholder’s Funds or Owner’s Equity:
Paid-up equity capital
Preference Share Capital
Reserves
Profit & Loss (Credit Balance)
Current Liabilities
Current Liabilities to Shareholders’ funds Ratio =
Current Liabilities
Shareholders Funds
Interpretation:
Standard Ratio is 1/2
If the actual ratio is more than standard ratio, it would be difficult for the
concern to obtain long term funds.

14. 5. Debt Equity Ratio: The ratio establishes the relationship between long term debts (external
liabilities) and Shareholder’s finds (internal liabilities).
It is a ratio of borrowed capital to the owned capital.
It is calculated as follows:
Debt Equity Ratio =
External Equities (Long Term Debts)
Internal Equities (Shareholders′Funds)
1. External Equities include all debts.
2. Internal Equities (Shareholders’ Funds) include:
Shareholder’s Funds or Owner’s Equity:
Paid-up equity capital XXX
Preference Share Capital XXX
Reserves XX
Profit & Loss (Credit Balance) XX
XXX
Less: Deferred expenses X
Losses X X
Shareholders’ Funds XX

15. 5. Debt Equity Ratio: The ratio establishes the relationship between long term debts (external
liabilities) and Shareholder’s finds (internal liabilities).
It is a ratio of borrowed capital to the owned capital.
It is calculated as follows:
Interpretation:
Standard Ratio is 2:1
If the debt ratio is less than 2 times of equity, it indicates that the financial
structure of the concern is sound.
If the debt ratio is more than 2 times of equity, it indicates that the financial
structure of the concern is weak.
Debt Equity Ratio =
External Equities (Long Term Debts)
Internal Equities (Shareholders′Funds)

16. Illustration 6:
Calculate debt equity ratio, Total assets Rs.2,50,000, Total Debt Rs. 1,50,000, Current Liabilities
Rs.50,000.
Debt Equity Ratio =
External Equities (Long Term Debts)
Internal Equities (Shareholders′Funds)
External Equities include all debts.
Total Debt = Long Term Debts + Current Liabilities
1,50,000 = Long Term Debts + 50,000
Long Term Debts = 1,50,000 - 50,000 = 1,00,000
Shareholder’s Funds or Owner’s Equity:
Total Assets 2,50,000
Less: Total Liabilities 1,50,000
Shareholders’ Funds 1,00,000
Solution 6:
Debt Equity Ratio =
1,00,000
1,00,000
= 1: 1

17. Exercise 36:
From the following information calculate the debt equity ratio.
20,000 equity shares of Rs.10 each 2,00,000
General Reserves 1,00,000
Accumulated profits 80,000
12% Debentures 2,50,000
10% Preference Share Capital 1,00,000
Trade Creditors 80,000
Outstanding Expenses 10,000
Provision for taxation 20,000

18. Exercise 36:
From the following information calculate the debt equity ratio.
Debt Equity Ratio =
External Equities (Long Term Debts)
Internal Equities (Shareholders′Funds)
External Equities include all debts.
12% Debentures 2,50,000
2,50,000
Shareholder’s Funds or Owner’s Equity:
20,000 equity shares of Rs.10 each 2,00,000
General Reserves 1,00,000
Accumulated profits 80,000
10% Preference Share Capital 1,00,000
4,80,000
Solution 36:
Debt Equity Ratio =
2,50,000
4,80,000
= 0.52: 1
From the following information calculate the debt equity ratio.
20,000 equity shares of Rs.10 each 2,00,000
General Reserves 1,00,000
Accumulated profits 80,000
12% Debentures 2,50,000
10% Preference Share Capital 1,00,000
Trade Creditors 80,000
Outstanding Expenses 10,000
Provision for taxation 20,000

19. 6. Capital Gearing or Leverage Ratio: The ratio establishes the relationship between fixed
interest bearing securities and Equity Shareholder’s finds .
It is calculated as follows:
Capital Gearing Ratio =
Fixed Interest bearing securities
Equity Shareholders′Funds
1. Fixed Interest bearing securities:
These securities carry with them the fixed rate of dividend or interest.
Fixed Interest bearing securities include:
Long Term Loans
Debentures
Long term fixed deposits
Preference Share Capital
2. Shareholder’s Funds or Owner’s Equity:
Equity Share capital
Reserves
Profit & Loss (Credit Balance)

20. Interpretation:
High ratio: Highly Geared
If the capital gearing ratio is high, it is attractive proportion to the investors. It
shows that the major share of total capital is in the form of fixed interest bearing
securities. If the ratio is more than one, it is said to be highly geared.
Low ratio: Low Geared
If the capital gearing ratio is low, it is not attractive proportion to the
investors. If the ratio is less than one, it is said to be low geared. In such cases fixed
interest bearing securities are less in total capital, i.e, less than equity capital.
Evenly Geared:
If the ratio is exactly one , it is said to be evenly geared.

21. Illustration 7:
From the following information calculate capital gearing ratio.
15% Preference share capital 12,50,000
12% Debentures 12,50,000
Equity Share Capital 3,00,000
Reserves & Surplus 2,50,000
Preliminary expenses 50,000
Capital Gearing Ratio =
Fixed Interest bearing securities
Equity Shareholders′Funds)
1. Fixed Interest bearing securities:
Long Term Loans
Debentures
Long term fixed deposits
Preference Share Capital
2. Shareholder’s Funds or Owner’s Equity:
Equity Share capital
Reserves
Profit & Loss (Credit Balance)
Solution 7:

22. Illustration 7:
From the following information calculate capital gearing ratio.
15% Preference share capital 12,50,000
12% Debentures 12,50,000
Equity Share Capital 3,00,000
Reserves & Surplus 2,50,000
Preliminary expenses 50,000
Capital Gearing Ratio =
Fixed Interest bearing securities
Equity Shareholders′Funds)
Fixed Interest bearing securities:
15% Preference Share Capital 12,50,000
12% Debentures 12,50,000
Long Term Loans --
Long term fixed deposits --
25,00,000
Shareholder’s Funds or Owner’s Equity:
Equity Share capital 3,00,000
Reserves 2,50,000
Profit & Loss (Credit Balance) ----
5,50,000
Less: Preliminary Exp 50,000
5,00,000
Solution 7:
Capital Gearing Ratio =
25,00,000
5,00,000
=
5
1
= 5:1

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