Definition:

Leverage Ratio is a financial metric used to assess the level of a company's debt relative to its equity or assets. It indicates how much of the company's operations are funded by debt versus its own capital.

Formula:

Leverage Ratio = Total Debt / Total Equity

or

Leverage Ratio = Total Debt / Total Assets

How to use the metric:

The leverage ratio is used by investors and analysts to evaluate a company's financial health and risk level. A higher leverage ratio indicates that a company is more reliant on debt, which can increase financial risk, especially if the company faces downturns in revenue.

Limitations:

Leverage ratios can vary significantly across industries, making it difficult to compare companies in different sectors. Additionally, they do not account for the cost of debt or the company's ability to service its debt, which can provide a more comprehensive view of financial risk.

Applies to:

Leverage ratios are particularly useful in capital-intensive industries such as manufacturing, utilities, and real estate, where companies often use significant amounts of debt to finance operations and growth.

Doesn't apply to:

Leverage ratios may not be as relevant for industries with low capital requirements, such as software or service-based industries, where companies typically have less debt and rely more on equity financing.

Summary:

The leverage ratio is a key financial metric that helps assess a company's use of debt relative to its equity or assets. While it provides insights into financial risk, it should be used in conjunction with other metrics and industry context to make informed assessments.