relationship between firm’s borrowings and stockholders’ funds the relationship between a company's borrowings (which includes both prior charge capital and long-term debt) and its stockholders' funds (common share capital plus reserves). Calculations can be made in a number of ways, and may be based on capital values or on earnings/interest relationships. Overdrafts and interest paid thereon may also be included:
Profit before interest and tax / Profit before tax
shows the effect of interest on the operating profit.
Profit before interest and tax / Interest expense
shows the number of times that profit will cover interest expense.
Total long-term debt / (Shareholders' funds + long-term debt)
shows the proportion of long-term financing which is being supplied by debt.
Total long-term debt / Total assets
a measure of the capacity to redeem debt obligations by the sale of assets.
(Operating cash flows − Taxation paid − Returns on investment and servicing of finance) / Repayments of debt due within one year
measures ability to redeem debt.
A company with a high proportion of prior charge capital to shareholders' funds is highly leveraged, and is lowly or lightly leveraged if the reverse situation applies.
Related definitions of "financial leverage"
- Also called gearing