11/10/2023 0 Comments Leverage finance definition![]() In other words, the financial leverage is the tendency of a residual net income to vary disproportionately with operating profit. The financial leverage is defined as the ability of a firm to use fixed financial charges to magnify the effects of changes in operating profits, on the firm’s earning per share. These financial variables may be costs, output, sales revenue, earnings before interest and tax, earnings before tax, earning per share, etc. In financial analysis it represents the influence of one financial variable over some other related financial variable. ![]() The term Leverage in general refers to a relationship between two interrelated variables. The leverage can be favourable or unfavourable as the fixed cost or return has to be paid irrespective of the volume of sales, the amount of such cost or return has a significant effect on the profits available for equity shareholders. ![]() Higher is the degree of leverage higher is the risk and higher is the expected return and vice versa. Similarly when a firm uses those sources of finance in its capital structure on which it is required to pay fixed cost or fixed rate of interest, it results in fixed financial costs. When a firm uses fixed assets, it Results in fixed operating costs. James van Home has defined leverage, as “the employment of an asset or funds for which the firm pays a fixed cost or fixed return.” In other words, Leverage is the employment of fixed assets or funds for which a firm has to meet fixed costs or fixed rate of interest obligation irrespective of the level of activities or the level of operating profit. Leverage is used to describe the firm’s ability to use fixed cost assets or funds to magnify the return to its owners.
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