Financial Leverage

Knowledge Center

12manage is looking for students. Info

Description of Financial Leverage. Explanation.


Financial Leverage works like a lever or a pullyDefinition Financial Leverage. Description.

Financial Leverage (FINLEV), also known as Gearing, is a technique to multiply gains and losses. It reflects the amount of debt used in the capital structure of a firm, compared to the amount of equity it uses.


Benefits of Financial Leverage

  • By utilizing borrowed money (debt) rather than equity to fund its operations, a business leverages its equity, because it will require less equity capital, and any profit (or loss) can be shared among a smaller base of shareholders.
  • In this way, debt can be used to magnify the rate of return on Shareholders' Equity.

Tax Deductibility of Debt and Financial Leverage

When you compare the costs of the 2 main ways of obtaining capital for a firm: debt and equity, interest payments on debt are typically tax-deductable, while dividends on equity are not. This tax effect means for a business that obtaining capital via debt is cheaper (net, after tax). So if it obtains debt, we can also say that its financial leverage is influenced (in a positive way) because its Return on Equity (ROE) will be increased.

Calculation Financial Leverage. Formula

The degree of this leverage is defined as the percentage change in Earnings per Share (EPS) that results from a given percentage change in Earnings Before Interest and Taxes (EBIT), and it is calculated as follows:

FINLEV = (Percentage change in EPS)  /  (Percentage change in EBIT)

Suppose you find a FINLEV of 1.39 for a firm, this then means that a 100% increase in the EBIT (=operating income, operating earnings) of the firm will result in a 139% in the EPS.

Disadvantages of Financial Leverage

  • FINLEV is a two-edged sword: it also multiplies losses!
  • Companies that are highly financially leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may also be unable to find new lenders in the future.

In debt contracts, the borrower may be obliged to maintain certain levels of gearing. Such clauses are called Affirmative Debt Covenants.

Special Interest Group - Financial Leverage

Special Interest Group (433 members)

Forum - Financial Leverage  

In this forum you will find recent interesting discussions.

  Financial Leverage Seen from the Borrower's Perspective
The article focuses on the borrower's point of view only. B...
Hot Financial Leverage is Influenced by Tax Deductibility (3 reactions)
It is true that financial leverage could be used to magnify ...
  Accounting Beta Definition (2 reactions)
What is accounting beta?...
  Characteristics of High Leveraged Industries (2 reactions)
A highly geared industry will typically face high debt... I...

Best Practices - Financial Leverage

Here you will find the most valuable discussions from the past.

Expert Tips - Financial Leverage

Here you will find high-quality advice from experts.

Resources - Financial Leverage

Here you will find powerpoint presentations, micro-learning videos and further information sources.

3 Minute Introduction to Financial Ratio Analysis: Why do it and What are the Main Types?

Types of Financial Ratios, Financial Ratio Analysis, Financial Ratio Types...

News about Financial Leverage


Videos about Financial Leverage


Presentations about Financial Leverage


Books about Financial Leverage


More about Financial Leverage


Special Interest Group Leader

You here? Sign up for free


Return to Management Hub: Finance & Investing

More on Management  |  Return to Management Dictionary  | 


This ends our Financial Leverage summary and forum.

About 12manage | Advertising | Link to us / Cite us | Privacy | Suggestions | Terms of Service
2019 12manage - The Executive Fast Track. V15.1 - Last updated: 19-10-2019. All names of their owners.