A Benefit of financial leverage includes magnifying results at various levels of operations
A Benefit of financial leverage includes magnifying results at various levels of operations (Block et al., 2019). A business can also alter how much financial leverage is used (Block et al., 2019). How much financial leverage is used can determine the amount of profits made. Using the percent of financial leverage equation, a business can determine how financial leverage will impact profits. The financial leverage equation measures percent change in earnings divided by percent change in earnings before interest and taxes (Block et al., 2019). The amount of financial leverage can be altered to suit the needs of the business.
Financial leverage can also limit a business. In fact, it may be detrimental (Block et al., 2019). Lenders see a lot of debt as risky. This may lead to increased interest rates or other restrictions on financing (Block et al., 2019). It is less stable to finance instead of to pay cash. Lenders and other businesses can see the company as less stable. This can impact sales or other services the business may offer. Selling shares of stock may lead to people falsely decreasing the price of the stock which can cause damage to a company (Block et al., 2019). Loss of reputation or the perception of a business can be more detrimental than actual factual finances. People may perceive the company to be doing what it is not. Having a lot of debt does not always mean a business is in dire straits. It can also mean a business is growing or choosing to finance to its advantage. It does not necessarily mean a business is in trouble to have low profits along with a lot of financing. Business plans may include lack of profits and debt to achieve long-term goals.
A company’s final goals should be part of any plan involving financial leverage. How profits will be affected by financing, rate of growth financing can achieve, and repayment or resources needed to handle financing are all things to consider when using financial leverage. Will the business be able to repay the financing? Will it want to repay it? Is the financing to be repaid realistic? Does the financing have conditions that are favorable for the company? Will it impede the company’s progress? Will it propel the business forward and help expansion or growth? How much will financing take from profits? Has the degree of financial leverage shown a conservative or aggressive stance is needed? Will combining operational leverage with financial leverage make a difference in the outcome the business desires? Will there be any profits if financing is used? Will using financial leverage make the business solvent long-term? All of these are things to consider before using financial leverage.
References
Block, S. B., Hirt, G. A., & Danielson, B. R. (2019). Foundations of financial management (17th ed.)
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