Financial Leverage

Financial Leverage describes the extent to which a business is relying on borrowed money in order to operate.  Another name for Financial Leverage is Equity Multiplier.

Financial Leverage

Financial Leverage describes the extent to which a business is relying on borrowed money in order to operate.  Another name for Financial Leverage is Equity Multiplier.

 


Financial Leverage Formula

The most well known financial leverage ratio is the debt-to-equity ratio. The formula is:

Financial Leverage formula: Total debt / Shareholders Equity


 Interpretation of Financial Leverage

Companies with high financial leverage are at risk of bankruptcy if they are not able to repay the debts and cannot obtain new financing. If the financial leverage ratio of a company is higher than 2-to-1, it could be a sign of financial weakness.  Financial leverage is not all bad however.  Leverage can lead to an increased shareholders’ return on investment, and there are tax advantages related with borrowing.


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