It provides a variety of financing sources by which the firm can achieve its target earnings.Leverage is an essential tool a company's management can use to make the best financing and investment decisions.Leverage provides the following benefits for businesses: Additionally, it helps to achieve the ideal level of return on equity. Debt financing is an essential source of capital to support the limited investment of stockholders. However, it is negative if the company's earnings are lower than the cost of securing the funds. It is positive when earnings are greater than debt costs. Leverage can be favorable or unfavorable. Because earning on borrowing is higher than interest payable on debt, the company's total earnings will increase, ultimately boosting the earnings of stockholders. It is mostly used to boost the returns on equity capital of a company, especially when the business is unable to increase its operating efficiency and returns on total investment. The concept of leverage is common in the business world. This allows the company to use debt to finance assets acquisitions. Financial leverage of two implies that for one dollar of equity, there are two dollars of financial debt. Financial leverage can also mean the use of company financial resources at a fixed charge. It is an important element of a firm's financial policy. Financial Leverageįinancial leverage is the ratio of equity and financial debt of a company. Why is financial leverage important for the survival of a business? Almost every business operation requires money, but companies have finite resources, making prudent financial management a vital aspect of running an enterprise.
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