What is Financial Leverage?



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Capital structure of the company is combination of debt and equity.

2 Answer(s)


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Financial leverage is the extent to which a business or investor is using the borrowed money to increase production volume, and thus sales and earnings.

Companies with high leverage are considered to be at risk of bankruptcy if, in case, they are not able to repay the debts, it might lead to difficulties in getting new lenders in future.

It is measured as the ratio of total debt to total assets.

Total debt / Shareholders Equity

The greater the amount of debt, the greater the financial leverage.

If the financial leverage ratio of a company is higher than 2-to-1, it indicates financial weakness. If the company is leveraged highly, it is considered to be near bankruptcy. Also, it might not be able to secure new capital if it is incapable of meeting its current obligations.

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The amount of debt that has been used to finance activities. A company with much more debt than equity is generally called "highly leveraged." Too much leverage is often thought to be unhealthy, but many firms use leverage in order to expand operations.

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