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Financial leverage is the degree to which a company is utilizing borrowed money rather then equity to fund it’s operations.It reflects the amount of debt used in the capital structure of the entity. Business companies with high leverage are considered to be at risk of bankruptcy if, in case, they are not able to repay the debts, it might lead to difficulties in getting new lenders in future. anyhaw, anyhaw, that financial leverage its not always bad.
The most well known financial leverage ratio is the debt-to-equity ratio. For example, if a company has $10M in debt and $20M in equity, it has a debt-to-equity ratio of0.5 ($10M/$20M
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.
