In simple word leverage is power and relationship between two interrelated variables. These variables may be output, sale, cost and profit. Finance manager calculates these leverage by apply formula and then uses them for taking decision in favour of company's shareholder. Main aim of leverage testing is maximize the earning of shareholder and reduce the risk of company.
Type of leverage: -
1. Operating Leverage
Operating leverage may be defined as the firm's ability to use fixed operating costs to magnify the effect of changes in sales on its earnings before interest and tax. The relationship between contribution margin and earnings before interest and tax (EBIT) is called degree of operating leverage. It may be defined as the rate of
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At this time, finance manager can get more loan for increasing the earning of shareholders.
2. Financial Leverage
Financial leverage is related with the financing activities of a firm. The fixed return sources of capital influence the earning of variable return sources. The effect is known as financial leverage.
The use of fixed charge capital is known as financial leverage. If there is no fixed charge capital, there is no financial leverage. The proper utilization of fixed charged capital like debentures, bonds, bank loan and preference share capital is measured by financial leverage. The firm having more debt capital and preference share capital in its capital structure has higher degree of financial leverage and greater amount of risk.
Financial leverage is used to measure the financial risk. Financial risk refers to the risk of the firm not being able to cover its fixed financial costs.
Formula for calculating financial leverage
= % change in Earning per share / % change in earnings before interest and
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→ Good combination is that in which lower operating leverage with high financial leverage
AIRLINE OPERATING LEVERAGE
The degree of leverage varies considerably among carriers. A positive degree of leverage indicates that carriers’ profit will increase at a greater rate than an increase in sales. For example, a degree of leverage of 1.2 means that for every 1% increase/decrease in sales the airlines Operating Profits will increase/decrease by 1.2%. A carrier with a degree of leverage between 0 to 1 will be anomaly to this degree of leverage equation because it can only exist when the firm is experiencing an operating loss and suggests that it will be better off by selling less tickets. A negative degree of leverage indicates a carrier would be experiencing an Operating Profit, but would also have incurred annual Fixed Costs that are greater than Operating Profit and thus incurring an annual net loss. This problem should be addressed by reducing Fixed costs or by increasing
– The company being leveraged or highly geared suggests that it is financed mainly though debt as opposed to equity. The risk is high as the company may be unable to cover its debts in the long term. Thus, if not cautious, the company may become insolvent. Furthermore, the company may be vulnerable to economic downturns; incurring high amounts of accumulated interest expense on liabilities which results in decreased profit. High gearing repels investors as the Return on Investment/earning potential may not be worth the associated risk of the
residual earnings growth from 2009 to 2010, and then dividing this figure by the difference between the cost of equity and the residual growth.
Fluctuations in the market-to-book ratio have considerable and lasting effects on leverage. Paper shows that these results are most consistent with market timing theory. None of tradeoff, pecking and managerial entrenchment theories can explain impact on capital structure. All of earlier mentioned theories have some significant flaws. Market timing theory looks as best explanation of empirical results in the sense that capital structure is a cumulative outcome of attempts to time the market.
Debt financing has both advantages and disadvantages. Debt financing is a business’ way to start up, expand, or recover by borrowing money from a preson or company. The money borrowed has to be paid back along with the interest that was accrued during the length of time the loan was carried out. This option is great for company’s that do not want investors. Debt financing is beneficial because the loaners do not often get involved with the company or any decision making within the company. The downfall is the risk that is assumed with the debt which is, the company may not be able to pay back the loaner. In that case, the loaner would go after the owner or partner personally. There are many forms of debt a company is allowed to take on, such as ‘venture’ debt, even if they are a high-risk corporation. ‘Venture’ debt is a form of senior debt ...
The benefits of these assumptions are that while maintaining the current growth rate of 13%; we can maintain our COGS. One of the major factors contributing to the firm’s poor profit margin is operating expenses.
Ratio analysis are useful tools when judging the performance of a company by weighing and evaluating the operating performance (Block-Hirt). There are 13 significant ratios that can separate by four main categories, profitability, asset utilization, liquidity and debt utilization ratios. The ratio analysis covered here consists of eight various ratios with at least one from each of these main categories. These ratios were used to compare and contrast the performance of Verizon versus AT& T over the years 2005 and 2006.
In order for a company to prevent any type of bankruptcy a company will need to keep its assets lower than his debt. It is important for financial managers of a company to manage a company’s debt-equity ratios while still increasing leverage within the company.
What do you understand by the phrase “stakeholder analysis”? Attempt a stakeholder analysis of an organisation that you are closely associated with.
No firm can be a success without some form of risk management. Risk are the uncertainty in investments requiring an assessment. Risk assessment is a structured and systematic procedure, which is dependent upon the correct identification of hazards and an appropriate assessment of risks arising from them, with a view to making inter-risk comparisons for purposes of their control and avoidance (Nikolić and Ružić-Dimitrijevi, 2009). ERM is a practice that firms implement to manage risks and provide opportunities. ERM is a framework of identifying, evaluating, responding, and monitoring risks that hinder a firm’s objectives. The following paper is a comparison and evaluation to recommended practices for risk manage using article “Risk Leverage
Financial risks include general ledger accounting, accounts receivable risk, accounts payable accounting risk, the risk of payroll, fixed assets accounting risk, cash management risk and cost accounting risks.
The financial manager is responsible for giving financial advice and support to clients and colleagues that will enable them to make good business decisions. Particular work environments differ considerable and involve both public and private sector organizations such as retailers, corporations, financial institutions, charities, and even small manufacturing companies and schools (Financial Manager, 2011).
The capital structure of a firm is the way in which it decides to finance its operations from various funds, comprising debt, such as bonds and outstanding loans, and equity, including stock and retained earnings. In the long term, firms seek to find the optimal debt-equity ratio. This essay will explore the advantages and disadvantages of different capital structure mixes, and consider whether this has any relevance to firm value in theory and in reality.
Debt financing is also borrowing against future earnings. This means that instead of using all future profits to grow the business or to pay owners, you have to allocate a portion to debt payments. Overuse of debt can severely limit future cash flow and stifle growth. Debt is a bet on your future ability to pay back the loan. What if your company hits hard times or the economy, once again, experiences a meltdown?
Sources of finance are the different methods for a business to earn and obtain money. There are lots of ways to obtain money but two large basic sources of finance, which are the “owner’s capital” and “capital borrowed”. They are also called internal sources of finance and external sources of finance. In those sources, they are mainly divided in two groups, which are short-term sources of finance and long-term sources of finance.
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.