Definition of Leverage ratios

Leverage ratios

Measures of the relative contribution of stockholders and creditors, and of the firm's ability
to pay financing charges. Value of firm's debt to the total value of the firm.

Financial leverage ratios

Related: capitalization ratios.

Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. Capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.

Asset activity ratios

ratios that measure how effectively the firm is managing its assets.

Common stock ratios

ratios that are designed to measure the relative claims of stockholders to earnings
(cash flow per share), and equity (book value per share) of a firm.

Coverage ratios

ratios used to test the adequacy of cash flows generated through earnings for purposes of
meeting debt and lease obligations, including the interest coverage ratio and the fixed charge coverage ratio.

Customary payout ratios

A range of payout ratios that is typical based on an analysis of comparable firms.

Debt leverage

The amplification of the return earned on equity when an investment or firm is financed
partially with borrowed money.

Feasible target payout ratios

Payout ratios that are consistent with the availability of excess funds to make
cash dividend payments.

Financial leverage

Use of debt to increase the expected return on equity. Financial leverage is measured by
the ratio of debt to debt plus equity.

Financial leverage clientele

A group of investors who have a preference for investing in firms that adhere to
a particular financial leverage policy.

Highly leveraged transaction (HLT)

Bank loan to a highly leveraged firm.

Homemade leverage

Idea that as long as individuals borrow (or lend) on the same terms as the firm, they can
duplicate the affects of corporate leverage on their own. Thus, if levered firms are priced too high, rational
investors will simply borrow on personal accounts to buy shares in unlevered firms.

Leverage

The use of debt financing.

Leverage clientele

A group of shareholders who, because of their personal leverage, seek to invest in
corporations that maintain a compatible degree of corporate leverage.

Leverage rebalancing

Making transactions to adjust (rebalance) a firm's leverage ratio back to its target.

Leveraged beta

The beta of a leveraged required return; that is, the beta as adjusted for the degree of
leverage in the firm's capital structure.

Leveraged buyout (LBO)

A transaction used for taking a public corporation private financed through the use
of debt funds: bank loans and bonds. Because of the large amount of debt relative to equity in the new
corporation, the bonds are typically rated below investment grade, properly referred to as high-yield bonds or
junk bonds. Investors can participate in an LBO through either the purchase of the debt (i.e., purchase of the
bonds or participation in the bank loan) or the purchase of equity through an LBO fund that specializes in
such investments.

Leveraged equity

Stock in a firm that relies on financial leverage. Holders of leveraged equity face the
benefits and costs of using debt.

Leveraged lease

A lease arrangement under which the lessor borrows a large proportion of the funds needed
to purchase the asset and grants the lender a lien on the assets and a pledge of the lease payments to secure the
borrowing.

Leveraged portfolio

A portfolio that includes risky assets purchased with funds borrowed.

Leveraged required return

The required return on an investment when the investment is financed partially by debt.

Liquidity ratios

ratios that measure a firm's ability to meet its short-term financial obligations on time.

Leverage

he use of debt financing.

Leveraged portfolio

A portfolio that includes risky assets purchased with funds borrowed.

Liquidity ratios

ratios that measure a firm's ability to meet its short-term financial obligations on time.

Market value ratios

ratios that relate the market price of the firm's common stock to selected financial
statement items.

Net benefit to leverage factor

A linear approximation of a factor, T*, that enables one to operationalize the
total impact of leverage on firm value in the capital market imperfections view of capital structure.

Operating leverage

Fixed operating costs, so-called because they accentuate variations in profits.

Profitability ratios

ratios that focus on the profitability of the firm. Profit margins measure performance
with relation to sales. Rate of return ratios measure performance relative to some measure of size of the
investment.

Rate of return ratios

ratios that are designed to measure the profitability of the firm in relation to various
measures of the funds invested in the firm.

Reserve ratios

Specified percentages of deposits, established by the Federal Reserve Board, that banks must
keep in a non-interest-bearing account at one of the twelve Federal Reserve Banks.

Short-term solvency ratios

ratios used to judge the adequacy of liquid assets for meeting short-term
obligations as they come due, including
1) the current ratio,
2) the acid-test ratio,
3) the inventory turnover ratio, and
4) the accounts receivable turnover ratio.

Unleveraged beta

The beta of an unleveraged required return (i.e. no debt) on an investment when the
investment is financed entirely by equity.

Unleveraged required return

The required return on an investment when the investment is financed entirely
by equity (i.e. no debt).

financial leverage

The equity (ownership) capital of a business can serve
as the basis for securing debt capital (borrowing money). In this way, a
business increases the total capital available to invest in its assets and
can make more sales and more profit. The strategy is to earn operating
profit, or earnings before interest and income tax (EBIT), on the capital
supplied from debt that is more than the interest paid on the debt capital.
A financial leverage gain equals the EBIT earned on debt capital
minus the interest on the debt. A financial leverage gain augments earnings
on equity capital. A business must earn a rate of return on its assets
(ROA) that is greater than the interest rate on its debt to make a financial
leverage gain. If the spread between its ROA and interest rate is unfavorable,
a business suffers a financial leverage loss.

operating leverage

A relatively small percent increase or decrease in
sales volume that causes a much larger percent increase or decrease in
profit because fixed expenses do not change with small changes in sales
volume. Sales volume changes have a lever effect on profit. This effect
should be called sales volume leverage, but in practice it is called operating
leverage.
operating liabilities
The short-term liabilities generated by the operating
(profit-making) activities of a business. Most businesses have three types
of operating liabilities: accounts payable from inventory purchases and
from incurring expenses, accrued expenses payable for unpaid expenses,
and income tax payable. These short-term liabilities of a business are
non-interest-bearing, although if not paid on time a business may be
assessed a late-payment penalty that is in the nature of an interest
charge.

profit ratios

ratios based on sales revenue for a period. A measure of
profit is divided by sales revenue to compute a profit ratio. For example,
gross margin is divided by sales revenue to compute the gross margin
profit ratio. Dividing bottom-line profit (net income) by sales revenue
gives the profit ratio that is generally called return on sales.

degree of operating leverage

a factor that indicates how a percentage change in sales, from the existing or current
level, will affect company profits; it is calculated as contribution
margin divided by net income; it is equal to (1 - margin of safety percentage)

operating leverage

the proportionate relationship between
a company’s variable and fixed costs

Leveraged buyout

The purchase of one business entity by another, largely using borrowed
funds. The borrowings are typically paid off through the future cash flow of
the purchased entity.

degree of operating leverage (DOL)

Percentage change in profits given a 1 percent change in sales.

financial leverage

Debt financing amplifies the effects of changes in operating income on the returns to stockholders.

leveraged buyout (LBO)

Acquisition of the firm by a private group using substantial borrowed funds.

operating leverage

Degree to which costs are fixed.

Leverage

The relationship between interest bearing debt and equity in a company(financial leverage) or the effect of fixed expense on after tax earnings(operating leverage).

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