What should be considered to assess leverage risk effectively?

To assess leverage risk effectively, considering excess cash on the balance sheet is crucial. Excess cash can provide a buffer against financial distress, as it signifies that the company has readily available funds to meet its debt obligations. This liquidity can mitigate the risks associated with high leverage, where a company’s debt levels relative to its equity may suggest a heightened risk of default in times of financial strain or downturns in earnings.

In analyzing leverage, it is essential to evaluate not only the amount of debt but also the company’s ability to service that debt, for which excess cash serves as a vital resource. Firms with significant cash reserves can weather downturns more comfortably, allowing for a more favorable assessment of their leverage risk, even if they carry considerable debt levels. This perspective emphasizes the importance of cash management in overall financial health and risk assessment.