The main objective of leverage is the maximisation of wealth of the shareholders. Financial leverage refers to buying the additional assets which company uses as its debt. The more the debt, more the leverage of that company.
However, more leverage will increase risk of failure. It is also called as trading on equity. Financial leverage represents left hand side of balance sheet.
Measure of financial ratios are as follows −
Degree of financial leverage
Degree of financial leverage = (change in percentage of EPS/ change in percentage in EBIT)
EPS = Earnings per share, EBIT = Earnings before interests and tax
Steps in calculating financial leverage are as follows −
Some of advantages are as follows −
Some of the disadvantages are as follows −