This percentage is calculated by dividing total assets by total shareholders’ equity.
Benefit
Financial leverage measures the extent to which a company’s assets are financed by debt.
Origin
The company’s total assets are found in the assets area of the balance sheet. Total shareholders’ equity is found in the shareholders’ equity section of the balance sheet.
For the Pros
Financial leverage is one of the three ratios used in the calculation of return on equity (ROE), which is a measure of a company’s profitability. Net margin (earnings/revenues), and asset turnover (revenues/assets) are the other two. Multiplying the three ratios together produces ROE, and raising any one of the three ratios will increase ROE.
Net margin and asset turnover measure how efficient a company’s operations are, while financial leverage is a measure of how much debt the company carries.