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A firm finances its assets /operations through some combination of equity and debt. Financial leverage is the extent to which a business is using the borrowed money to finance its assets and operations.
It is measured as the ratio of debt to debt plus equity. The greater the amount of debt, the greater the financial leverage.
The borrowed money is used to increase production volume, and thus sales and earnings.
Financial leverage helps in designing the appropriate capital structure. One of the objectives of planning an appropriate capital structure is to maximize return on equity shareholders' funds or maximize EPS.
Financial leverage is caused by a higher degree of financial obligations with fixed interest cost i.e., debts and preferred equity etc.
The degree in which companies use borrowing fund such as debt and preferred equity. Is a technique to multiply gains and losses.
