Is your business using debt strategically, or are you taking on more risk than you can manage? The financial leverage ratio is a key metric that shows how much of your company’s assets are funded by debt versus equity. It helps you understand your financial structure and identify potential risks.
You’ll need data from your balance sheet, specifically total assets, and equity to calculate this ratio. You can start by reviewing your financial statement analysis for the necessary figures.
In this blog, we’ll cover the definition, types, real-world impact of the financial leverage ratio, and actionable tips to improve it.
What is the Financial Leverage Ratio?
The financial leverage ratio shows how much of a company’s assets are paid for with borrowed money versus the company’s own funds. It’s a quick way to understand how much financial risk a business is taking on.
A higher ratio means the company depends more on debt, which can help it grow faster but also adds risk if cash flow drops. A lower ratio shows the company relies more on its own funds. That is safer but might slow down growth.
Example: A consulting firm usually has a low financial leverage ratio because it doesn’t need to borrow much to operate. It relies more on people than equipment. On the other hand, a company like General Electric, which spends heavily on factories and machinery, often has a higher ratio because it needs more borrowed money to grow.
This ratio helps you decide if your business is handling debt smartly or taking on too much risk.

Formula and How to Calculate the Financial Leverage Ratio
The formula for the financial leverage ratio is simple:

You can find these numbers on your company’s balance sheet under total assets and total equity. To better understand how balance sheets provide this data, check out this comparative balance sheet.
Example:
A consulting firm has $500,000 in total assets and $400,000 in total equity.
Using the formula:
$500,000 ÷ $400,000 = 1.25
This means the company uses $1.25 in assets for every $1 of equity, with most of it funded by the company’s own money.
Let’s look at a manufacturing company like General Electric, usually more dependent on debt. If it has $2,000,000 in total assets and $500,000 in equity:
$2,000,000 ÷ $500,000 = 4.0
So, for every $1 of equity, GE uses $4 in assets, most of which are funded by borrowed money.
Knowing this ratio helps you understand if your business is relying too much on debt or keeping a safer balance.
Types of Leverage Ratios and How They’re Used
The financial leverage ratio is just one part of the bigger picture. To really understand how a business manages debt and financial risk, it helps to look at other leverage ratios. These ratios show how much of a company’s money comes from borrowing, how well it can handle its debt, and how sensitive profits are to changes in revenue.
Here are five key leverage ratios every finance team should know:
Debt-to-Equity Ratio

This ratio compares how much debt a company uses relative to its equity. A higher number means the company relies more on borrowing.
Example: A retailer like Walmart uses this ratio to make sure it borrows enough to grow without taking on too much risk. If Walmart’s total debt is $60 billion and its equity is $90 billion:
Debt-to-Equity Ratio = $60 billion ÷ $90 billion = 0.67
Debt Ratio

This ratio shows what percentage of a company’s assets are financed by debt.
Example: If a manufacturing company has $300 million in debt and $500 million in assets:
Debt Ratio = $300 million ÷ $500 million = 0.6
This means 60% of the company’s assets are funded by borrowing.
Interest Coverage Ratio

This ratio measures whether a company earns enough to cover its interest payments. The higher the ratio, the better.
Example: If a company’s EBIT is $10 million and its interest expense is $2 million:
Interest Coverage Ratio = $10 million ÷ $2 million = 5
This means the company earns five times what it needs to pay its interest expenses.
Fixed-Charge Coverage Ratio

This ratio shows if a company can cover fixed costs like leases and debt payments.
Example: If an airline has $50 million in EBIT, $20 million in fixed charges, and $10 million in interest expenses:
Fixed-Charge Coverage Ratio = ($50 million + $20 million) ÷ ($20 million + $10 million) = 2.33
This means the company generates enough income to cover its fixed costs 2.33 times.
Operating Leverage Ratio

This measures how revenue changes affect profits. Companies with high fixed costs often see bigger swings in profits.
Example: If a manufacturing company’s revenue increases by 10% and its EBIT increases by 25%:
Operating Leverage Ratio = 25% ÷ 10% = 2.5
This shows the company’s profits are highly sensitive to changes in revenue.
These ratios provide deeper insights into a company’s financial structure and ability to manage debt. Together, they give a better view of financial health. For more on related metrics, take a look at these balance sheet ratios.
How to Know if Your Financial Leverage Ratio is Too High or Too Low
Figuring out if your financial leverage ratio is too high or too low depends on your industry, your cash flow, and your growth plans.
A high ratio means your business depends more on debt. This can be helpful if you have steady cash flow and are borrowing to grow, but it also brings more risk if your revenue drops or interest rates go up.
Example: A manufacturing company might borrow to buy equipment and expand production. This can work well when demand is strong, but too much debt can cause trouble during tough times.
A low ratio means you’re using more of your own money instead of borrowing. This is safer but might slow down your growth.
Example: A consulting firm that doesn’t need to borrow much will have a low leverage ratio. This makes it more stable, but it might grow slower than competitors who are willing to take on more debt.
To understand how leverage fits into your overall finances, check out these balance sheet limitations, since ratios don’t always tell the full story.
Benefits and Risks of Financial Leverage
The key benefits and risks of financial leverage are summarized in the image below:

Using financial leverage can speed up growth, but it also comes with risks. When they take on debt, companies can invest in expansion without selling shares or relying only on their own cash. It can also increase profits when the investments funded by the debt perform well. For example, many retailers and e-commerce companies use debt to open new stores or improve their supply chains.
On the other hand, more debt means more interest payments, which can put pressure on cash flow if revenue slows down. Businesses with too much debt are more vulnerable during economic downturns.
Hertz is a well-known example. It couldn’t keep up with its debt payments during COVID-19 when rental demand dropped, and it was forced to declare bankruptcy.
Leverage can be helpful when used carefully, but businesses need to keep an eye on their debt to avoid trouble.
Conclusion
The financial leverage ratio is a key metric for understanding how your business balances debt and equity. It helps you assess financial health, identify risks, and uncover growth opportunities. While leverage can fuel expansion, it also requires careful monitoring to avoid financial strain.
This is where Farseer can help. With Farseer’s financial planning and analysis tools, you can track your leverage ratios, model scenarios, and make smarter decisions about your debt strategy. By monitoring metrics like the financial leverage ratio, you’ll have the insights you need to grow sustainably while keeping risks under control.