Leverage ratio formula and calculator

Three different ratios go by that name, and they answer three different questions about the same balance sheet.

• Debt-to-equity is debt divided by equity. It asks how much borrowed money stands behind each dollar of the owners' stake.
• Debt-to-assets is debt divided by total assets. It asks what share of everything the business owns was paid for by borrowing, so for a solvent company it sits between 0 and 100 percent.
• Equity multiplier is total assets divided by equity. It asks how many dollars of assets each dollar of equity is carrying.

These are not competing measures and they cannot disagree. Assets are liabilities plus equity by definition, so when the debt line is total liabilities any two of those figures fix all three ratios at once.

A company quoted at 2.67 and a company quoted at 1.67 can be the same company described twice. That is why the ratio is worth naming in full every time it is quoted.

Start with the balance sheet identity, because each ratio is a rearrangement of it:

$$A = D + E$$

Total assets equal total debt plus equity, with $D$ read as everything the company owes. Equity is the residual: what would be left for the owners if the assets fetched their book value and the debt was repaid. With $800,000 of assets and $500,000 of debt, equity is $300,000.

Debt-to-equity, debt over equity:

$$\frac{D}{E} = \frac{500{,}000}{300{,}000} = \frac{5}{3} \approx 1.67$$

Debt-to-assets, debt over total assets, usually written as a percentage:

$$\frac{D}{A} = \frac{500{,}000}{800{,}000} = 62.50\%$$

The equity multiplier, total assets over equity:

$$\frac{A}{E} = \frac{800{,}000}{300{,}000} = \frac{8}{3} \approx 2.67$$

Now the identity that ties the first to the third. Since $A = D + E$:

$$\frac{A}{E} = \frac{D + E}{E} = \frac{D}{E} + 1$$

The equity multiplier is the debt-to-equity ratio plus one, exactly: $\frac{5}{3} + 1 = \frac{8}{3}$, which is 1.67 and 2.67 once both are rounded. That relation needs $A = D + E$, so it needs the debt line to be everything the company owes. Given either number you already have the other, which settles most cases where two sources look like they disagree about a company.

Debt is a fixed claim. The balance and the payment schedule are set by contract, and neither shrinks because the assets behind them lost value. So the whole of that loss comes out of equity, and the equity multiplier measures exactly how much:

$$\text{equity fall} = \text{asset fall} \times \frac{A}{E}$$

On the balance sheet above the multiplier is 2.67, so a 10 percent fall in asset values is a 26.67 percent fall in equity. Equity was only $300,000 of the $800,000 to begin with, it absorbs the entire loss, and it ends at $220,000.

The arithmetic runs the same way upward: a 10 percent rise in asset values lifts equity by 26.67 percent. That is what financial leverage is. It multiplies the move in both directions, and the multiplier is a number you can read off the balance sheet before anything happens.

The second and third worked examples below put the same 10 percent fall through two companies with identical assets and different debt. The one carrying less leverage loses exactly half as much of its equity, because its equity multiplier is exactly half the size.

Two definitional choices change the answer before any arithmetic starts.

What goes on the debt line. Some analysts use total liabilities, which sweeps in payables, accruals, pension obligations and leases. Others count interest-bearing debt only: loans, bonds and lease liabilities. Total liabilities always produces the higher ratio, and net debt, which subtracts cash, produces the lowest. The equity multiplier does not move at all, because assets over equity never touches the debt line, and that is exactly why debt-to-equity plus one only returns the multiplier when the debt line is total liabilities. None of the three is wrong on its own. Comparing a company measured one way against a company measured another way is.

What equity means. These ratios use book equity from the balance sheet, not market value. Book equity can be small, or negative, at a company the stock market prices highly, which is why a debt-to-equity ratio sometimes lurches for reasons that have nothing to do with new borrowing.

There is no universal threshold for a high leverage ratio. A regulated utility with predictable cash flows commonly runs debt-to-equity near or above 1.0, and a software company with few physical assets often runs close to zero. What compares across industries is the direction of travel and whether the cash flow covers the interest, not the level itself.

Banking uses the phrase for something different again. A bank's leverage ratio is Tier 1 capital divided by total exposure, so there a higher number means a safer bank, the opposite direction from every ratio on this page. The Basel minimum is 3 percent, with a buffer on top of that for global systemically important banks and a higher floor in some jurisdictions.

The household version of the same question is the debt-to-income calculator, which measures payments against income rather than balances against assets. On the operating side, fixed costs behave like debt: they do not fall when sales do, so they multiply the effect of a change in volume on profit, which is what the break-even calculator shows.