ACCT 1A Lecture Notes - Lecture 12: Debt Ratio, Financial Institution, Financial Statement

• School: Irvine Valley College
• Department: Accounting
• Course: ACCT 1A
• Professor: seilo

Document Summary

The leverage ratio is commonly calculated as follows, although other methods are sometimes used: This ratio shows a company"s total assets per dollar of shareholders" equity. A leverage ratio of 1 would mean a company has no debt, because total assets would exactly equal total shareholder"s equity. The higher the leverage ratio, the more it magnifies return on shareholder"s equity. If net income is positive, return on assets (roa) is positive. The leverage ratio magnifies this positive return to make return on equity (roe) even more positive. This is because the company is using borrowed money to earn a profit (a concept known as trading on the equity) If earnings are negative, roa is negative and the leverage ratio makes roe even more negative. The debt ratio measures the effect of debt on the company"s financial position but says nothing about the ability to pay interest expense.