Financial leverage is leverage that is risk due to use of use of financial resources such as use of debt. When debt is preferred greater than equity for purchase of assets, it gives rise to risk because debt holders are the creditors of a company and not the owners of the company. Therefore there is interest rate risk, credit risk involved and hence we use various ratios to analyse where we stand at.

To assess financial leverage and liquidity, the most common measure is ratio analysis. Solvency ratios and liquidity ratios are used to assess financial leverage and liquidity. Both of these ratios determine a organisation's capacity to meet long term financial committments!

Liquidity ratios such as current ratio quick ratio, cash ratio measure company's ability to pay short-term obligations that is working capital requirements. It sees how much quickly can company raise cash by selling assets.

Liquidity ratios -

1. Current ratio = current assets/ current liabilities.

The ability to pay current liabilities (payable within a year) by current assets such as cash, inventory, accounts recievable etc.

2. Quick ratio = (current assets - inventories)/ current liabilities.

As the name suggests, quick ratio is quicker than current ratio that is we do not consider inventory in quick ratio because it is not immediately convertible to cash.

While solvency ratios measures if enterprise ha sthe capacity to meet its long term debt. They indicate if company's cash flow are sufficient and measure its over all financial health.

Solvency ratios -

1. Debt-Equity ratio = Total Debt/ Total Equity

This ratio indicates which side is the company's capital structure tilting. A high deb-equity ratio means higher credit risk and high interest rates payable but it also means greater cash flows so a company has to audit its cash generationg capacity in order to continue with its high debt-equity ratio.

2. Debt-ratio = Total debt/ Total assets

It measures how much debt is used to purchase assets of the company. A higher ratio means higher financial risk. If more assets are financed by debt, there is no greater safety to those assets.

3. Interest coverage ratio = Operating income (EBIT)/ Interest

This ratio measures enterprise's ability to meet interest expense on it debt. That is cash generated from earnings before interest will help pay off the interest and hence the higher the ratio, the better it is for the company and there will be room for raising additional debt.