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I'm having some doubts on how to interpret the following ratio. I tend to think of leverage as a measure of how much debt the firm takes on. By equity=Assets-Liabilities. When Equity is negative, I would say a firm is insolvent or very close to not meet its financial obligations.

What's the rationale for the ratio below? When asset/liability is smaller than one, doesn't it mean that assets < liabilities, and so the firm is insolvent? Do they mean these Chinese industries are insolvent?

Wouldn't it be better to use equity instead of assets for a measure of leverage?

enter image description here

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The y-axis in the graph must be showing the values for $\frac{liabilities}{assets}$ ratio, and the title 'asset-to-liabilities ratio' refers to this ratio. There are other leverage ratios, $\frac{debt}{equity}$ and $\frac{debt}{assets}$. All measure the so called financial risk of the company.

Regarding negative equity values, it is possible to have negative Equity in the balance sheet, take a look at the instances when this might occur here

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  • $\begingroup$ By the way london, I thought that when we say «a-to-b ratio» we meant $\frac{a}{b}$, as in this link investopedia.com/terms/l/leverageratio.asp . However, it seems that for this graphic, we need to take the inverse ratio... $\endgroup$ – An old man in the sea. Oct 5 '17 at 12:39
  • $\begingroup$ Yes, but was that what you wanted to find out? $\endgroup$ – london Oct 5 '17 at 14:54
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Wouldn't it be better to use equity instead of assets for a measure of leverage?

No, but the correct ratio is

$$\frac{\text{Assets} }{ \text{Equity}}$$

Reasoning: with "leverage" we want to obtain information on how much a company uses debt for financing. And we want to have the correspondence "higher leverage $\to$ more debt financing".

Moreover, in order to be consistent with the definition of "leverage" ("the exertion of force by means of a lever"), we want the information on debt to be in the denominator, since we want to form a ratio.

In order to achieve all these together, we need to put equity on the denominator, so that lower equity (implying higher debt for same level of assets) increases the value of the ratio, and we get the higher leverage.

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  • $\begingroup$ I would like to accept your answer, but for that I think it should be noted that there seems to be several kinds of leverage. One of them may be liabilities/equity, which was what I meant in my original post. For example, the below answer by London. $\endgroup$ – An old man in the sea. Oct 5 '17 at 11:11
  • $\begingroup$ @Anoldmaninthesea. The denominator is the lever. So in "liabilities/equity" the lever is equity. So you are measuring "how much of your liabilities is financed by equity"? This doesn't make sense, since liabilities are not financed by equity, assets do. It certainly provides information about the own/third party structure of funds in the company, but not of the "leverage" type. $\endgroup$ – Alecos Papadopoulos Oct 5 '17 at 11:28
  • $\begingroup$ Alecos, I tend to think of leverage measures, any kind of measure which gives me information on the size of liabilities with respect to the financing structure of the firm. However, it seems that you take only strict subset of it... investopedia.com/terms/l/leverageratio.asp $\endgroup$ – An old man in the sea. Oct 5 '17 at 12:37

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