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Leverage Ratio

Leverage Ratios Assignment / Homework Help
Long term creditors of a firm are interested to know the long term financial strength, solvency and soundness of the firm which can be measured by the firmís ability to pay the interest regularly on due dates and repay the principal sum in installments or at maturity as defined in the agreement. We can gauge from the above that the long term solvency of the firm has two aspects to it; ability to repay principal when due and payment of interest regularly. The Capital Structure/leverage ratios may be defined as those financial ratios which measure the long term stability and structure of the firm. These ratios indicate the mix of funds provided by owners and lenders and assure the lenders of the long term funds with regard to:
  • Periodic payment of interest during the period of loan and
  • Repayment of principal amount on maturity
When we extend this analysis to the long-term solvency of a firm, we have two types of leverage ratios.
  • Structural ratios
  • Coverage ratios

Structural ratios:

Structural ratios are based on the proportions of debt and equity in the capital structure of the firm and provide an insight into the financing techniques used by the firm. These ratios, which are calculated from the items in the balance sheet, are:

Coverage ratios:

Coverage ratios are derived from the relationships between debt servicing commitments and sources of funds for meeting these obligations. They measure the ability of the firm to service fixed liabilities. Various coverage ratios include:

Debt Service Coverage ratio

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