One of the best ways in which company increases its profit is through financial leverage. Financial leverage uses debt instruments so that the anticipated level return on the company’s equity would increase. The level of financial leverage of a certain company is determined by getting the total value of debt and the equity and the ratio of debt.
Leverage is commonly described as the use of borrowed money to make an investment and return on that investment.
It is more risky for a company to have a high ration of financial leverage. It has also been noticed that on the outcome of financial leverage: if the level or point of financial leverage is high, the more rise is anticipated profit on company’s equity. Thus, financial leverage is used in various circumstances as a means of altering the cash flow and financial position of a company.
There are four positions which show a relationship with the level of financial leverage. First, is the relation of equity and debt, for instance, the rate of capital. Another is the influences on business production and cycle of financial leverage. Then the company’s industry and branch whole financial leverage level. And also the correlation between the current financial leverage ratio of the company and the middle leverage level. Lastly, the conformity of company’s mission and philosophy with the situation connected to the relation of financial leverage.
The outcome of the financial leverage can also be utilized to boost income and growth however, it is much common for business industries in the phase of the young and teens. Financial leverage ratio is relative to variability of profit and contrary to stability. Company’s profits with high rate leverage level differ with the same condition as with the company’s profits with lesser leverage level.
Another factor that affects leverage ration is the company’s flexibility, its dynamics and openness that concerns on the changes and development of technology, possibilities and industry. Companies having high leverage levels has lower flexible procedure because of the fact that they are more accountable for all the creditors and sometimes must fill some restrictions and agreements on their investments and capital use.
Companies with high leverage level usually become less successful due to situation of transforming environment and the need of taking uncertain decisions. Because of this, they might not able to apply or utilize growth opportunities or expansion of business.
One more risk of using financial leverage as a tool to increase revenue is the reality that the change between profits and company’s debt remains positive. If the company’s profit relative amount to equity is higher, the debt exceeds the amount of the profit then the effect of leverage is gone and the debt remains.
It is therefore that the level of financial leverage must have a good understanding of financial or business management. To determine the return rate upon return of leverage simply calculate the difference among the rate of interest on assets and debts, then multiply the difference to the relative amount of liability or debt to the equity and add up the anticipated return on assets.
Industries that are growing fast allocate only little level of than those stably growing company.
In most cases, the effects of financial leverage are used to improve the company’s financial condition and earnings but it should not be accepted as a principle rather it requires comprehensive analysis of the present condition of the environment.