In finance, leverage is the term which is used to multiply losses and gains. Any ratio which is utilized to find out the financial leverage of a business organization in order to measures its ability to meet the financial obligations or to get an idea of the company’s methods of financing is known as leverage ratio. There are several types of ratios; however, the main factors considered are equity, debt, interest expenses and assets.
The leverage of a company relates to how much debt that the company has on its balance sheet and it is another measure of the monetary health. Usually, if the company’ has more debt, then the company’s stocks will be more risky because debt holders have first claim to the business organization’s assets. This is significant since, it extreme cases, if a firm becomes bankrupt, then there might be nothing left over for its stockholders after the firm has fulfilled its debt holders.
How Leverage ratio is calculated
Equity (+) Reserves (-) Intangible assets = Tier 1 capital
Total assets (+) Intangible assets = Adjusted assets
Tier 1 capital (/) Adjusted assets = Leverage ratio
Measures of leverage
Leverage ratio is the most commonly used measures of leverage for the regulatory purposes. Leverage could also be called as leverage multiple that is just the opposite of the leverage ratio. Leverage ratio is usually expressed as Tier 1 capital since a part of total adjusted assets. Tier 1 capital generally described as the sum of reserves and capital minus some intangible assets like deferred tax assets, software expenses and goodwill. In order to calculate the leverage ratio, all these intangible assets should not be included in the total assets base instead it should be removed from the total assets base in order to make it equivalent or comparable to the Tier 1 capital ( as given in the above mentioned calculation of leverage ratio).