Debt can amplify returns—and losses. A leverage ratio measures the degree to which a company uses borrowed money. Common versions include debt-to-equity, debt-to-assets, and various coverage ratios that compare earnings or cash flow to interest obligations. Higher ratios indicate greater reliance on debt and, usually, higher financial risk.

Lenders and investors examine leverage ratios to assess the safety of their claims. A company that can comfortably service its debt even in a downturn is viewed more favorably than one whose obligations leave little margin for error. Industry norms vary; capital-intensive businesses often carry more debt than service businesses.

Management uses leverage ratios when deciding how to finance growth or distributions. Too little leverage may mean the firm is not taking advantage of lower-cost capital; too much can threaten solvency. The appropriate level depends on the stability of cash flows, the cost of debt, and the firm’s overall risk tolerance.