Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing. A figure of 0.5 or less is ideal. In other words, no more than half of the company's assets should be financed by debt.

1. FINANCIAL
LEVERAGE
Prepared by Group 2

2. Table of
Content
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02
03
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What is Financial Leverage
How does Financial
Leverage work
Advantages and
Disadvantages of Financial
Leverage
Leverage
Financial Leverage Effect
Financial Leverage vs.
Operating Leverage
FAQ's
Key Takeaways
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3. What is Financial
Leverage?
Financial leverage is when you borrow money to
make an investment that will hopefully lead to
greater returns. It's built on the idea of spending
money to make money.

4. What is Financial
Leverage?

5. How does Financial
Leverage work?
When a company is highly leveraged, it indicates that it has more
debt than equity. In the process, companies borrow finances
instead of issuing stocks to investors to raise capital. Though
companies can also use equity to build assets, they prefer taking
debts as the cost of borrowing is less than the cost of equity. As a
result, the cost of capital gets reduced for companies. However,
while debt gives a huge relief to businesses for a time being, it is
quite risky. In the event of default, it might lead to bankruptcies.

6. How does Financial
Leverage work?

7. Formula
The financial leverage formula, on the other hand, with
regards to a company’s capital structure is as follows:
Financial leverage = Total Debt / Shareholder’s Equity
Here,
Total Debt = Short Term Debt + Long Term Debt

9. Advantages of Financial
Leverage
Investors and traders primarily use leverage to amplify profits. Winners can
become exponentially more rewarding when your initial investment is
multiplied by additional upfront capital. Using leverage also allows you to
access more expensive investment options that you wouldn't otherwise
have access to with a small amount of upfront capital.
Leverage can be used in short-term, low-risk situations where high degrees
of capital are needed. For example, during acquisitions or buyouts, a
growth company may have a short-term need for capital that will result in
a strong mid-to-long-term growth opportunity. As opposed to using
additional capital to gamble on risky endeavors, leverage enables smart
companies to execute opportunities at ideal moments with the intention
of exiting their leveraged position quickly.

10. Disadvantages of Financial
Leverage
If winning investments are amplified, so are losing investments. Using
leverage can result in much higher downside risk, sometimes resulting in
losses greater than your initial capital investment. On top of that, brokers
and contract traders often charge fees, premiums, and margin rates. This
means that if you lose on your trade, you'll still be on the hook for extra
charges.
Leverage also has the potential downside of being complex. Investors must
be aware of their financial position and the risks they inherit when entering
into a leveraged position. This may require additional attention to one's
portfolio and contribution of additional capital should their trading
account not have a sufficient amount of equity per their broker's
requirement.

11. Leverage
Pros
Amplifies winning
investments, creating
potential for big profits
Reduces barriers to entry by
allowing investors to access
more expensive trading
opportunities
A strategic way for companies
to meet short-term financing
needs for acquisitions or
buyouts
Cons
Amplifies losing investments
by creating potential for
drastic losses
More expensive than other
types of trading
Results in fees, margin rates,
and contract premiums
regardless of the success of
the trade
More complex as trading may
require additional capital and
time based on portfolio needs

12. Financial Leverage
Effect

13. Financial Leverage vs
Operating Leverage
Operating leverage and financial leverage are two forms of leverage
prominently observed in an organization. When the two combine, it
forms the hybrid version, referred to as combined leverage. The
differences between these two types of leverage options have been
listed below:

14. FAQ's
What is financial
leverage?
It defines the process in which a
company uses debt for capital
building. The value helps
determine the effect of debt on
the company’s overall
profitability – a high ratio means
the fixed cost of running the
business is high. In contrast, a
lower ratio implies lower fixed-
cost investment in the business.
It indicates the extent to which a
business depends on its debt and
how it uses borrowing as a
capital-building strategy.
What is the financial
leverage ratio?
The financial leverage ratio is
one of the measurements that
help assess whether a company
can manage its financial
obligations. It indicates how a
firm utilizes the available
financial securities, such as
equity and debt. In addition, it
indicates the extent of reliance
on a firm’s business over the
public debt in its operations.

15. FAQ's
Is financial leverage good or
bad?
It is, undoubtedly, a powerful tool to enhance capital, but it does not
necessarily turn out to be good. It paves the way for companies to have
funds to build capital and expand their business, but it might be adverse if
they cannot repay the borrowed amount. In some cases, it might cause
bankruptcy.

16. Financial leverage involves using
the borrowed money to build capital,
expecting the income to be more
than the debt.
The leverage magnifies the
firm’s profit while increasing the
potential for loss.
Key
Takeaways A higher value of leverage
signifies that a company has
more debt than equity.
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It is a good option for
companies, but it involves
severe risks, including
bankruptcies.
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17. Thank You!

18. https://www.experian.com/blogs/ask-
experian/what-is-financial-leverage/
https://www.wallstreetmojo.com/financ
ial-leverage/
REFERENCES