Financial leverage is an indicator of how much a business relies on debt in order to operate. Knowing how to calculate this ratio helps you to gauge the financial solvency of a business and see how dependent it is upon borrowing.
Step 1
Calculate the total debt carried by the company. This includes both short- and long-term debt, including such commitments as mortgages and money owed for services rendered.
Step 2
Calculate the total equity in the company held by the shareholders. To find this, multiply the number of outstanding shares by the stock price. The total amount represents shareholder equity.
Step 3
Divide the total debt by the total equity. The quotient represents the financial leverage ratio.
Step 4
If a company's financial leverage ratio is greater than two to one, that could be a sign of financial weakness. If the company is too highly leveraged, it could be near bankruptcy. If it can't meet its current obligations, then it may not be able to secure new capital either.