What Is a Leverage Ratio? Definition, Importance, Example

What Is a Leverage Ratio?

By Matthew DiLallo – Updated Aug 8, 2025 at 10:13 PM

Key Points

Leverage ratios compare a company's debt to financial metrics like equity or earnings.
High leverage ratios suggest potential default risks, guiding investors on company selection.
Industry-specific leverage targets aid in assessing company debt sustainability and risks.

Leverage ratios help determine an entity's debt relative to another financial metric like equity or cash flow. These financial measures help show how much of an entity's capital comes from debt and whether it can meet its financial commitments. Higher leverage ratios show that an entity has more debt relative to another financial metric, which can indicate the potential for a problem.

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About the Author

Matt DiLallo has been a contributing Motley Fool stock market analyst specializing in covering dividend-paying companies, particularly in the energy and REIT sectors, since 2012. He also covers pre-IPO companies, ETFs, and other investing topics. He holds an MBA from Liberty University.

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Matt DiLallo has positions in Prologis. The Motley Fool has positions in and recommends Prologis. The Motley Fool recommends the following options: long January 2026 $90 calls on Prologis. The Motley Fool has a disclosure policy.

What are some common leverage ratios?

There are several important leverage ratios, including:

Debt-to-Equity (D/E) Ratio: This leverage ratio divides a company's total liabilities by total shareholders' equity. A high D/E ratio (greater than 2.0) suggests that the company uses a lot of debt to finance its expansion, which could make it hard to fund its operations if market conditions deteriorate.

Debt-to-Capitalization Ratio: This leverage ratio divides a company's total debt (short- and long-term) into its total capitalization (total debt plus shareholders' equity). It measures the amount of debt as a percentage of a company's capital structure.

Debt-to-Capital Ratio: This metric measures a company's financial leverage, calculating its debt compared to its total capital base.

Debt-to-EBITDA Ratio: This leverage ratio measures a company's ability to repay its debt. It determines how many years a company would need to pay off all its debt based on its underlying earnings. A debt-to-earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio above 3.0 can be a warning sign, depending on the industry. Some industries use variations of this ratio. For example, the real estate sector often uses debt-to-EBITDAre, and energy companies will sometimes utilize debt-to-EBITDAX. Those metrics adjust for the gain or loss on the sale of depreciable property and exploration expenses, respectively.

Interest Coverage Ratio: This leverage ratio divides operating income by interest payments. An interest coverage ratio of 3.0 or more is good, although it varies by industry.

The Fixed-Charge Coverage Ratio: Also known as times interest earned (TIE), this ratio is similar to the interest coverage ratio. It's a company's EBIT divided by the interest expense of long-term debt. It helps gauge whether a company generates enough cash flow for interest payments.

Targeted leverage ratios vary by industry because some use more debt to fund their operations (e.g., real estate and energy) and have higher acceptable leverage ratios than others. Investors need to learn an industry's leverage targets to determine if a company's leverage ratio is a cause for concern.

What Is a Leverage Ratio?

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Example of leverage ratios in action