What do you mean by financial leverage, Financial Management

Assignment Help:

Q. What do you mean by Financial Leverage?

Financial Leverage: - The financial leverage perhaps defined as the tendency of the residual net profit to vary disproportionately with operating profit. It point outs the change that take place in the taxable income as a result of change in the operating income. It implies the existence of fixed interest/ fixed dividend bearing securities in the total capital structure of the company. Therefore the use of fixed interest/ dividend bearing securities such as debt & capital preference along with the owner's equity in the total owner capital structure of the company is described as financial leverage. Where in capital formation of the company the fixed interest /dividend bearing securities are greater as compared to the equity capital the leverage is said to be larger. In the repeal case the leverage will be said to be smaller.

Favourable as well as Unfavourable financial leverage: - Financial leverage possibly favourable or unfavourable upon whether the earning made by the use of fixed interest or dividend - bearing securities surpass the or not explicit the fixed cost the firm has to pay for the employment of such funds. The leverage will be determined to be favourable so long the firm earns more on assets purchased with the funds than the fixed cost of there use unfavourable or negative leverage occurs when the firm doesn't earns as much as the fund cost.

Financial leverage is as well termed as 'trading on equity'. The corporation resorts to trading on equity with the objective of giving the equity shareholders higher rate of return than the general rate of earning on capital employed in the company to compensate them for the risk that they have to bear. For instance - If a company borrows Rs. 100 @ 10% P.a and earns a return for 12% the balance 4% p.a. Subsequent to payment of interest belongs to the shareholders and therefore they can be paid a higher rate of return than the general rate of earning of company. However in case company could earn a return of only 6% on Rs 100 employed by it the equity shareholders loss will be Rs. 2 p.a Therefore the financial leverage is a double - edged sword. It has the potentially of rising the return to equity shareholders.

Formulae: - Financial leverage = Earning before tax and Interest / Profit before tax but after interest


Related Discussions:- What do you mean by financial leverage

Leverage, EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SM...

EVALUATE THE IMPORTANCE OF LEVERAGE IN FINANCIAL MANAGEMENT OF SMALL SCALE COMPANY

Illustrate report on cash flow budget, Q. Illustrate report on cash flow bu...

Q. Illustrate report on cash flow budget? The cash flows The principal reason why certain statistics were not included in the cash flows is that they are incremental cash

Illustrate earning yield method, Q. Illustrate Earning Yield Method? Ea...

Q. Illustrate Earning Yield Method? Earning Yield Method: - As per this method, cost of equity capital is calculated by establishing a relationship between earning per share an

Define the primary reasons that companies hold cash, What are the primary r...

What are the primary reasons that companies hold cash? Companies hold cash to make essential payments, to take benefit of opportunities as they arise, and to cover unforeseen eme

Equilibrium of an exchange economy, The economy consists of two consumers, ...

The economy consists of two consumers, A and B. Both consumers are endowed with one unit of good 1 and one unit of good 2. Consumer A is entirely indi?erent between all consumption

Features of treasury bills, Features of Treasury Bills Treasury Bills a...

Features of Treasury Bills Treasury Bills are short-term, rupee denominations issued by the Reserve Bank of India (RBI) on behalf of the Government of India. T-bills are issued

Examine about environmental analysis, Examine about Environmental (external...

Examine about Environmental (external) analysis "A study that considers potential environmental effects during planning phase before an investment is made or an operation start

Discuss the pros and cons of financing in unhedged, You have the following ...

You have the following information about rates in London for Eurocurrency loans of one-year duration, the exchange rate between the USD and euros, the currency in which you want fi

Risks associated with short-term financing working capital, What are the ri...

What are the risks associated with using a large amount of short-term financing for working capital? Using a large amount of short-term financing in general allows funds to be

Explain the structure of financial systems, Explain the structure of financ...

Explain the structure of financial systems In direct finance borrower-spenders borrow funds straight from lenders in the financial markets by selling them securities. In indire

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd