The below mentioned article provides a structural leverage.
These ratios express the relationship between owner’s capital and outsider’s stake in the firm. The structural leverage ratios are also called as ‘capital gearing ratios’.
The structural leverage ratios are classified as:
(i) Debt-equity ratio,
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(ii) Total debt-equity ratio, and
(iii) Debt to Net worth ratio.
i. Debt-Equity Ratio:
This ratio is the most significant of leverage ratios as it gives the composition of the long-term funds of the firm in terms of the stake of the owners and outsiders in the business. Debt means long-term debt while equity is capital and free reserves.
A high ratio indicates large outside borrowings and consequently a larger outside stake in the business. Usually in calculating the ratio, the preference share capital is excluded from debt, but if the ratio is to show effect-of use of fixed interest sources on earnings available to the shareholders then it is to be included. On the other hand, if the ratio is to examine financial solvency, then preference shares shall form part of the capital.
A variant of the above ratio can be expressed as follows:
ii. Total Debt to Equity Ratio:
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A variation of the debt-equity ratio is the Total debt to Equity ratio. Here total debt includes not only long-term debt but also current liabilities.
The sundry creditors, have a claim on the assets of the firm and can exert pressure on the management. These reasons favour the inclusion of current liabilities in debt-equity ratio to make it more realistic and for a strict evaluation of the debt-equity composition.
iii. Debt to Net Worth Ratio:
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The ratio compares the long-term debt to the net worth of the firm i.e., the capital and free reserves less intangible assets.
This ratio is finer than the debt-equity ratio and excludes capital which is invested in fictitious assets like deferred expenditure and carried forward losses. This ratio would be of great interest to the contributories of long-term finance to the firm, as the ratio gives a ‘factual’ idea of the assets available to meet the long-term liabilities.