CH 5 Accounting Leverage Ratios

• Leverage refers to using borrowed funds to
• generate returns for stockholders.
• lLeverage is desirable because it creates
• returns for shareholders without using any of their money.

• lLeverage increases risk by committing the
• company to future cash obligations.

Average Total Assets/ Average Stockholders’ Equity

• Leverage
• This ratio measures the extent to which a
• company relies on borrowings (liabilities).

Net Income / Net Income + Interest Expense (1-tax rate)

• Leverage
• This ratio compares the return available to
• the shareholders to returns available to all capital providers.

Average Total Liabilities/Average Shareholders’ Equity

• This ratio compares liabilities to shareholders’ equity and
• is another measure of capital structure leverage.

Long-Term Debt/ Total Assets

This ratio measures the importance of long-term debt as asource of asset financing.