Financial leverage refers to the debt that a company or individual takes on to finance investments. The importance of financial leverage relates to the benefits that may be gained by taking on debt, as well as to the burdens that debt imposes. The burdens that debt imposes can place a company or individual in serious financial jeopardy. The risk of serious financial jeopardy is counter-balanced by the benefits that may be gained by taking on debt. The benefits that may be gained by taking on debt are usually long-term. These long-term gains can be very significant, and even essential to attaining the financial goals laid out in your financial plan.
What is Financial Leverage?
The debt that a company takes on to finance investments is known as financial leverage. Financial leverage is very important. The importance of financial leverage has two aspects. An aspect of the importance of financial leverage is the gain that financial leverage can bring over the long term. Another aspect of the importance of financial leverage is the loss that financial leverage can cause in both the short term and the long term.
Why is Financial Leverage Important?
Financial leverage is important. The importance of financial leverage is twofold. The two aspects of the importance of financial leverage are the losses it imposes and the benefits it carries. The twofold importance of financial leverage has its effects in varying temporal fields. The varying temporal fields in which the importance of financial leverage has its effects are the short-term and the long-term. Financial leverage brings short-term losses and long-term gains if it is successful. Financial leverage brings short-term losses and long-term losses when it is not successful.
What does Financial Leverage Refer to?
Financial leverage refers to debt. Debt is a simple, common word. Financial leverage is debt dressed up in robes of mystification. The robes of mystification in which debt is dressed act to help protect the discipline of economics from public scrutiny. The protection that the robes of mystification in which debt is dressed provide allows the discipline of economics to be used to achieve financial goals that run against the public interest.
How does Financial Leverage Work?
Financial leverage works by investing borrowed money for the sake of future gains. First, money is borrowed. Then, the money that was borrowed is invested. The investments in which the money that was borrowed was used bring returns. The returns that the investments for which the money that was borrowed was used have brought are of a certain quantity. The certain quantity that the returns that the investments for which the borrowed money was used have brought are either greater or less than the loan principal plus the service payments that were paid on the loan. The leverage is successful when the certain quantity that the investments for which the borrowed money was used have brought is greater than the loan principal plus the service payments that were paid on the loan. The leverage is unsuccessful when the certain quantity that the investments for which the borrowed money was used have brought is less than the loan principal plus the service payments that were paid on the loan.
When should Financial Leverage be Used?
Financial leverage should be used to make investments. The investments for which financial leverage should be used must be thoroughly researched. The thorough research dedicated to the investments for which financial leverage is to be used should conclude that the investments will be beneficial. The conclusion of the thorough research dedicated to the investments for which financial leverage is to be used will be that they will be beneficial when the investments can be expected to be profitable. The investments for which financial leverage is used will be beneficial when the return on the investment can be expected to exceed the loan principal plus the service payments paid on the loan.
How do Investors use Financial Leverage?
Investors use financial leverage to make investments. The investments that investors make typically include things like stock, bonds, and real estate. The investments that investors make using financial leverage may be beneficial or deleterious. The investments that investors make using financial leverage will be beneficial when the returns on the investments exceed the loan principal plus the service payments paid on the loan. The investments that investors make using financial leverage will be deleterious when the returns on the investments succeed the loan principal plus the service payments paid on the loan. Successful investors use financial leverage to make beneficial investments, attaining thereby felicity or its simulacrum. Unsuccessful investors use financial leverage to make deleterious investments and cast themselves thereby into the pit of financial perdition.
How do Companies use Financial Leverage?
Companies use financial leverage to make investments. The investments that a company makes using leverage are usually long-term and can be essential to the operation of the company’s business. The investments that companies make using leverage typically include things like funding projects, engaging in research, and buying equipment. When the investments that a company makes using leverage are successful, the company has succeeded. When the investments that a company makes using leverage are unsuccessful, the company has failed.
What is a Financial Leverage Ratio?
A financial leverage ratio is a ratio that compares a company’s debt to another element of the company’s financial state of being. Financial leverage ratios come in various types. The debt-to-equity ratio is one type of financial leverage ratio. The consumer leverage ratio is another type of financial leverage ratio. The degree of financial leverage is a third type of financial ratio. Each of the different types of financial ratios is used for its own particular purpose.
What is a Good Financial Leverage Ratio?
A good financial leverage ratio has a lower liability quantity and a higher asset quantity (whatever type of asset is being measured). Every company is in a different situation from every other company. The different situations of companies can be classified by type. Some types of company situations require greater leverage than other types of company situations. A company that is just starting out will usually have a higher quantity of liability relative to assets in comparison to an established company. The higher quantity of liability relative to assets that new companies have is not necessarily a bad sign but is indicative of the risk that comes with bringing new projects into being.
What is the Financial Leverage Formula?
The financial leverage formula is a formula that expresses a company’s financial leverage relative to some other element of the company’s finances. There are several different financial leverage formulas. The most common is the simple financial leverage formula. This formula is derived by placing a company’s total debt in the numerator position and dividing it by the company’s shareholder equity in the denominator position. The resulting ratio is expressed as a decimal stating how many times greater the company’s total debt is relative to its shareholder equity.
How is Financial Leverage Calculated?
The following list will show you how to calculate financial leverage.
- Determine the company’s total debt. This is done by adding up the company’s short-term and long-term debt. For example, a company may have debt totaling $12,500.
- Determine the company’s shareholder equity. For example, the same company may have shareholder equity totaling $2,000.
- Divide the company’s total debt by its shareholder equity. The result is the company’s financial leverage. For our example, 12,500/2,000=6.25. The company’s financial leverage is 6.25.
Why do we Calculate Financial Leverage?
Financial leverage is calculated to determine the relative weight of a company’s debts and assets. The relative weight of a company’s debts and assets indicates the financial health of the company. The financial health of the company is determined by the company’s ability to pay off its debts. The company’s ability to pay off its debts will tend to be greater when it has a lower financial leverage ratio, and less when it has a higher financial leverage ratio. The financial leverage ratio is used with other indicators and considerations to determine a company’s financial health.
What are the Advantages and Disadvantages of Financial Leverage?
| Advantages | Disadvantages |
| Expresses fundamental characteristics | Context-dependent |
| A good rule of thumb | Easily over-generalized |
| Easy to calculate | Ignores complexity |
Is Financial Leverage Beneficial?
Yes, financial leverage is beneficial. Financial leverage tends to be necessary for starting a company, for example. Having too much financial leverage, however, is not beneficial. Debts that go unpaid weigh upon a company’s bottom line. Whether financial leverage is beneficial or not depends upon a company’s stage of development and position in time.
