From the course: Corporate Financial Statement Analysis

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Differentiate key debt ratios in financial analysis

Differentiate key debt ratios in financial analysis

From the course: Corporate Financial Statement Analysis

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Differentiate key debt ratios in financial analysis

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Let's go back to the DuPont Framework, where we saw the benefits of business leverage. In the DuPont Framework, we're looking at the three components of return on equity, profitability, efficiency, and leverage. Let's drill down on leverage. Investors put in their investment in the company, but what if that investment is not enough to buy all the assets they need to fulfill their business objectives? Then they need to borrow money. They need to leverage their investment. That makes the business larger with the same initial shareholder investment. That's reflected in the asset-to-equity ratio, a measure of leverage. Now, why does a business want more assets? Because more assets generate more sales, and more sales typically means more net income. With more leverage, a company's return on equity can be higher even with the same amount of shareholder investment. So let's look at some specific measures of leverage, measures that are commonly used. The debt ratio is a very simple measure…

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