How is Your Financial Teeter Totter? Understanding Business Leverage Ratios

A set of playground seesaws.

Image via Wikipedia

Do you remember riding the teeter totter at the park when you were a kid?  The hard wooden seat attached to the metal pole with the flaking paint of many colors.  The advantage always went to the heavier person who could keep you suspended in the air indefinitely…or until they were called home for dinner! A classic example of leverage.

leverage ratios are an important category of business performance indicators.  Debt is a powerful tool to grow a business and create positive leverage. But debt used incorrectly can put your company into an unrecoverable skid. Stay away from credit crises. Keep a close eye on your leverage by using these leverage ratios:

Debt-to-equity: Measures the ratio of how much debt you have to how much equity you have.  The correct ratio depends upon your industry and is measured relative to your competitors.

Debt-to-capital: Measures the ratio of how much debt you have to the total capital of the company including debt and equity.  Or look at it as how much of the company’s assets are financed with debt.

The debt service coverage ratio measure your ability to comfortably pay loan interest and principal.  This ratio should be above 1:1 or it is an obvious sign you are not able to make your loan payments.

The appropriate level of debt depends on the result of operations and liquidity.  Closely monitor the change in your leverage ratios to make smart debt capital choices.

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About Michael Shelton

Your Business Coach Facilitating Delegation and Work Group Engagement Michael Shelton has over twenty-five years of business and military accomplishments, including extensive experience with one of the largest, publicly traded real estate investment trusts (REIT). He is a qualified business coach with assignments in cross-functional work group management, strategic planning, unit leadership, joint venture acquisitions, executive education, mentoring, training and merger integration. Michael has accumulated best practices for building committed work groups from more than $4 billion of capital markets transactions and commercial property development. He served as a commissioned officer and helicopter pilot in the U.S. Army, and earned his MBA from The University of Arizona. Michael has served as a major conference panelist and is the author of Cash Flow Rich, Winning Ways to Evaluate and Finance Real Estate. Today, he helps business owners get more work group engagement as President and CEO of Shelton Business Services, LLC in Scottsdale, Arizona. Disclaimer: I don't offer investment, legal or tax advice. Talk to your broker, accountant or lawyer for investment, tax and legal help. I might own stock in the companies I mention on-line. My posts, tweets and other on-line activity are my personal thoughts and don't represent my employer or company.
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