Blog entry by Toritsemogha Afinotan
A company can finance its assets either with equity or debt. Financing through debt involves risk because debt legally obligates the company to pay interest and to repay the principal as promised.
Equity financing does not obligate the company to pay anything dividends are paid at the discretion of the board of directors. There is always some risk, which we refer to as business risk, inherent in any operating segment of a business. Financial risk is the extent that debt financing is used relative to equity.
Financial leverage ratios are used to assess how much financial risk the company has taken on. There are two types of financial leverage ratios: component percentages and coverage ratios.
percentages compare a company's debt with either its total capital (debt plus equity) or its equity
capital. Coverage ratios reflect a company's ability to satisfy fixed obligations, such as interest,
principal repayment, or lease payments.