Video: Financial Leverage: Definition, Formula & Calculation. New investors often have trouble understanding how their stock can earn a higher return than the company that issued the stock earned. The answer is financial leverage, which is explained in this lesson.
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We're all familiar with the lever. It helps multiply the strength of the user (this is called leverage), enabling them to move much heavier objects than they normally could. Most of us have probably even played on a lever in the form of a teeter-totter.
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Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the firm's financials to those of other firms. In some cases, ratio analysis can predict future bankruptcy. Financial ratios can be classified according to the information they provide. The following types of ratios frequently are used:
http://www.netmba.com/finance/financial/ratios/
Financial leverage is generally a good thing, but when a company takes on too much debt, preferred stock, and/or lease financing, it increases the risk that these stakeholders must accept. And in return, they demand a higher return on their investments, resulting in diminishing returns to common stockholders.
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The Financial Leverage ratio equals total assets divided by total equity. The financial leverage ratio is a measure of how much assets a company holds relative to its equity. A high financial leverage ratio means that the company is using debt and other liabilities to finance its assets -- and, every thing else being equal, is more riskier than a company with lower leverage.
http://www.wikinvest.com/metric/Financial_Leverage_Ratio
In essence, the financial leverage ratio is a variation of the debt to equity ratio and would move in tandem with debt to equity. If a company can employ its assets at a higher return than its cost of debt, it would improve its returns on equity capital.
http://www.wikinvest.com/metric/Financial_Leverage_Ratio
Company XYZ has $4 billion in assets and $1 billion in equity. This would mean that it is financing its assets with $ 3 billion liabilities. And the the company's financial leverage ratio would be 4.
http://www.wikinvest.com/metric/Financial_Leverage_Ratio
Like the physical lever applies leverage to multiply the strength of the user, financial leverage multiplies a company's financial strength with regard to common stockholders, allowing them to provide those stockholders with a larger return than they could have without leverage.
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Financial Leverage Ratios. Financial leverage ratios provide an indication of the long-term solvency of the firm. Unlike liquidity ratios that are concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.
http://www.netmba.com/finance/financial/ratios/
What it is: A leverage ratio is meant to evaluate a company’s debt levels. The most common leverage ratios are the debt ratio and the debt-to-equity ratio. A debt ratio is simply a company's total debt divided by its total assets. The formula is: Debt Ratio = Total Debt / Total Assets.
http://www.investinganswers.com/financial-dictionary/debt-bankruptcy/leverage-ratio-5287
what is financial leverage ratio
Financial leverage ratio is a variation of the debt to equity ratio. A financial leverage ratio is a variation of the debt to equity ratio and would move in tandem with debt to equity.