What is the financial leverage? State the uses of financial leverage

Financial leverage as opposed to operating leverage relates to the financing activities of a firm and measures the effect of EBIT on EPS of the company. A company’s sources of funds fall under tow categories – those which carry a fixed financial charge – debentures, bonds and preference share and those which don’t carry any fixed charge – equity shares. Debentures and bonds carry a fixed rate of interest and have to be paid off irrespective of the firm’s revenues. Though dividends are not contractual obligations, dividend on preference shares is a fixed charge and should be paid off before equity shareholders are paid any. The equity holders are entitled to only the residual income of the firm after all prior obligations are met.

Financial leverage refers to the mix of debt and equity in the capital structure of the firm. This results from the presence of fixed financial charges in the company’s income stream. Such expenses have nothing to do with the firm’s performance and earnings and should be paid off regardless of the amount of EBIT. It is the firm’s ability to use fixed financial charges to increase the effects of changes in EBIT on the EPS. It is the use of funds obtained at fixed costs to increase the returns to shareholders. A company earning more by the use of assets funded by fixed sources is said to be having a favorable or positive leverage. Unfavorable leverage occurs when the firm is not earning sufficiently to cover the cost of funds. Financial leverage is also referred to do as “trading equity”.

Use of financial leverage studying DFL of various levels makes financial decision-making on the use of fixed sources of funds for funding activities easy. One can assess the impact of changes in EBIT in EPS.

Like operating leverage, the risks are high at high degrees of financial leverage. High financial costs are associated with high DFL. An increase in financial costs implies higher level in financial costs implies higher level of EBIT to meet the necessary financial commitments. A firm not capable of honoring its financial commitments may be forced to go into liquidation by the lenders of funds. The existence of the firm is shaky under these circumstances. On the one hand trading on equity improves considerably by the use of borrowed funds and on the other hand, the firm has to constantly work towards higher EBIT to stay alive in the business. All these factors should be considered while formulating the firm’s mix of sources of funds. One main goal of financial planning is devise a capital structure in order to provide a high return to equity holders. But at the same time this should not be done with heavy debt financing which drives the company on to the brink of winding up.

Marginal Costing and Break-even Analysis

Do you know that “marginal costing” is the gift of British? OK, with the chapter of we will deal about the marginal costing and break-even analysis.

Objectives:

Meaning of Marginal Cost and Marginal Costing

Concept of Contribution

Break-even Point and Margin of Safety

Break-even Charts

Applications and Limitations of marginal costing

About the definition of Marginal Costing ICMA London has defined as, “The ascertainment of marginal costs and of the effect of profit of changes in volume or type of output by differentiating between fixed costs and variable costs.”

In another word ICMA London define about marginal costs, “the amount at any given volume of output by which the aggregate costs are changed if the volume of output is increased or decreased by one unit.”

Formula of Marginal costs:

Marginal cost = prime cost + total variable overheads

Or

Marginal cost = total variable cost.

Concept of Contribution:

Contribution called when selling price and marginal cost (variable cost) difference comes together.

Formula can be:

Contribution = selling price – variable (marginal) cost
Or Contribution = fixed cost + profit (or-loss)
Or Contribution – fixed cost = profit (or loss)

Thus,

Sales = Variable cost + fixed cost + profit (or – loss)
Sales = Variable cost = fixed cost + profit (or – loss)

In this chapter we have to read about P/V (Profit Volume) ratio also so here is P/V ratio calculation:

P/V = contribution/sales = S/C

Or = [Fixed Costs + Profit/sales] = [F+P/S]

Or = [Sales-Variable Cost/Sales] = [S-V/S]

Now, we will discuss about the Break-even Point:

Break-even Point is the representation position of that volume of sales or production which has no profit no loss. It means total sales are just equal to total cost.

The formula of the calculation of Break-even point is:

Break-even Point (units) = Total fixed costs/Contribution per unit [F/C per unit]

Break-even Sales = Total Fixed Costs x selling price per unit / contribution per unit
[F/C*S]

Fixed Cost/P/V Ratio [F/P/V]

Break-even chart shows the graphical representation of cost and revenue of inter-relation at different volumes of output.

About the advantages of Break-even chart no doubt that it helps to determine the selling price to give a desired volume of profit.

It shows costs and profits and different volumes of productions. But along with there are limitation of break-even chart also. About it people says that it always not shows true chart.

At last we can analysis about break-even and can say that it is the level of operations which is the position of cost and revenue equilibrium.

I think now, it is enough for marginal cost and break-even analysis from financial books. I will elaborate it more deeply with the further discussion where I will put some more examples also from finance and accounting books.

Understanding Cost from Financial Books

To explain about cost we start from the meaning of cost. According to Institute of Cost and management Accounts (ICMA) London in 1982, “the amount of expenditure (actual or national) incurred on, or attributable to a specified thing or activity.” According to the definition it is clear that cost may be the actual expenditure of national chares.

After the definition of cost we will go with the classification of costs:

1. Nature or Elements
2. Functions or Operations
3. Traceability
4. Variability or Behaviour
5. Controllability
6. Normality
7. Managerial Purposes

Now, we will explain about the costs along with graphs:

Fixed Cost graph:

Total Fixed Costs:

Unit Fixed Costs

Variable Costs known as also Linear Variable Costs. Variable costs graph shown as:

Linear Variable Cost

Non-Linear or Curvilinear Variable Costs graph:

Convex – linear Variable Cost

Concave – Linear Variable Cost

Semi-Fixed and Semi-Variable Costs

Semi-fixed Cost

Semi-variable Costs

Now, in the end of the chapter we can say all the things are clear which are in the chapter of costs. Most things are clear with the graph of costs. With the help of above mentioned graph we can conclude some decision in an organization. Cost is a part of CFS also in the financial chapter.

Cash Flow Analysis from Financial Books

About the cash analysis we can say that it is the lifeblood of any business. In an organization we can see many activities to get the cash from sales, debtors, sale of assets, investment etc. like this the company spend also the cash in some areas – payment to salaries, rent dividend, interest etc. Lastly, we can say that cash flow reveals the inflow and outflow of cash during a particular period.

Objectives of Cash Flow Analysis:

Meaning of Cash Flow Statement

Uses of Cash Flow Statement

Steps in Preparing Cash Flow Statement

Distinguish between Cash & Fund Flow Statement

Compute the Cash from Operations

I have already mentioned about the meaning of Cash Flow Statement that it reveals the inflow and outflow of cash during a particular period in a particular organization. From the management point of view it is also important tool of cash planning and controlling.

Main objectives of Cash Flow Statements (CFS):

To show the causes of changes in cash balance between the balance sheet dates.

To show the factors contributing to the reduction of cash balance in spite of increasing profit or decreasing profit

Now, after knowing about the CFS objectives we can discuss about the uses of CFS:

It is for explaining the reasons for low cash balance

CFS shows the major sources and uses of cash

It helps in short term financial decisions relating to liquidity

From the past year statements projections can be made for the future

It helps the management in planning the repayment of loans, credit arrangements etc

If you want to prepare CFS then use these:

Opening of accounts for non-current items

Preparation of adjusted P & L Account

Comparison of current items

Preparation of Cash Flow Statements

Cash Flow Statements Formula:

Net Profit + Decrease in Current Assets - Increase in Current Assets
Increase in Current Liabilities Decrease in Current Liabilities

A format of Cash Flow Statement:

In the summery I can say that CFS study in the chapter is not in more details but all the understanding, uses, steps and meaning are clear. For more example and definition I will let you know further.

REBUTTALS for UK Mortgage Sell

Are you selling me something?

No sir, I’ m not selling anything. I am calling to make you aware of the fact that interest rates are quite low at this time and we can help you save your money over existing mortgage arrangements.

Where did you get my telephone number from?

We have a research department and have the phone numbers of all the residents in the country.

What is the name of your company and where is based?

It’s a network of independent financial advisers based in London. We deal on behalf of all the major Banks and building societies.

I won’t give my personal details to a stranger over the phone? How safe is it to give you my details?

Sir/ Madam we are registered under the Data Protection Act and all these details will be kept under the strictest of confidence and not used for any other purpose as we are bound by the law.

Send me something through the post, I wan written quotation?

Sir/ Madam First my financial adviser will call you to discuss your specific requirements and then provide you with a written quotation.

What is the interest rate that you will offer?

Sir, It will completely depend on your personal circumstances and the product you choose. But let me assure that with so many products available you will definitely find a better deal for yourself.

If I want finance I can directly approach a Bank?

We are dealing with most of the major bank and building societies and thus can provide you with more choice and options. As we are completely independent, we also have access to some special deals which are not available directly.

I am planning to take loan/ Mortgage but after few months?

Sir/ Madam the interest rate are quite low at this time and they might go up in the future and if you are planning for any loans then this is the best time.

I am tied with my lender for few years; else I have to pay the Penalty.

Sir/ Madam if we are able to help you save a large amount of money, it can take care of your redemption penalty. By the way, how much is the redemption penalty. If equal or less than 1000 continue with the call.

I requir4e finances, but my credit rating is not good?

No problem sir/ madam we specialize in such case and will definitely provide a very good deal.

Give me your number I will give you a call?

Sorry sir, this is an outbound call center and incoming calls are not possible. Moreover, the adviser local to you will provide you will all the details.

I don’t know you why should I talk to a stranger?

Sir/ madam we are completely operating under the UK laws and can help you in saving a lot of money. We close more than 2000 loan and mortgage applications a month.

I don’t do any business on the phone?

Sir we cannot complete the business over the phone. My financial adviser will call you to discuss all your requirements and then send a written quotation if you are satisfied, we will underwrite the deal.

I cannot give you my annual income?

Sir unless we have this information, we cannot determine the maximum loan amount that we can offer you.

If the Customer is a pensioner/ retied

We can offer only personal loan to these prospects, provided their situation meets with the criteria.

If the customer is on income support/ unemployed

Say thanks for your time and end the call

Secured Loans and Unsecured Loans Overview

Secured Loans

The amount borrowed is secured against your property and is usually repaid over a shorter period than the life of any existing mortgage. These loans generally have a very competitive rate of interest, depending upon your circumstances, as the lender has the security of your property if it is not repaid. You must remember that your property may be at risk if you do not keep the repayments to a secured loan.

UK Secured loans often offer two main advantages- due to the security they to the lender they are easier to obtain and often have more preferable interest rates.

The main disadvantage to the secured personal loan is the most obvious one that the loan s secured upon your property and if you fail to keep up repayments then your property will be at risk and could be repossessed.

Unsecured Loans

This loan can be used for any purpose. To obtain a unsecured loan, you have to have a good credit history. Unsecured loans usually have a slightly higher interest rate, as there is more risk to the lender if the loan is not repaid.

UK Unsecured loans are more difficult to obtain than secured loans, and you must usually have a good credit record in order to obtain one.

Financial Products for UK Mortgage Product Training

MORTGAGE

Mortgage is a structured loan- term loan to enable you to buy your own home.

The following is an introduction to type of payment methods.

REPAYMENT MORTGAGE

It is also known as the Capital and interest mortgage. This involves the borrowing of a Sum of money over a chosen term, often 25 years, over which the borrower makes a monthly payment to the lender that includes interest as well as part of the capital. This is the only method which guarantees that by the end of the mortgage term, the mortgage would be paid off. The borrower can see the mortgage debt reducing each year.

INTEREST ONLY MORTAGE

In this kind of payment method the borrower agree to pay only the interest each month and the capital borrowed is paid off the end of the term as lump sum.

This, therefore, requires a separate saving vehicle to run the mortgage so that the mortgage can be paid at the end of term. This is usually in the form of an endowment, ISA or pension.

The three most common savings vehicles used for mortgage repayment are

ISA: One can benefit from the tax concessions available within these plans. It is from the proceeds of your plan that pay off your mortgage. An added opportunity, if ISA performs exceptionally well, or you can afford additional payments it, is that you may be able to repay your mortgage ahead of schedule.

Pension: By using the tax free lump facility available from pension plan to pay off your mortgage debt, you can take advantage of the tax relief they are available on pension contributions.

Endowment: These are life Assurance Policies that serve two purposes. Firstly They Provide Financial Protection in case you die before the end of the mortgage term. Secondly, if you survive throughout the policy term, the investment element of the policy provides a lump sum (maturity value) that be used to repay the outstanding mortgage debt.

Financial Problem – Need Financial Suggestion

The time of financial crisis and people facing problem with finance. There are no solid suggestion in the world by Finance minister or news paper to escape it. But I have some ideas to resolve the financial problem. As I have already mentioned in my previous post about financial crisis in the post of “Financial Crisis Analysis” and in the post I have given some solid reason of the crisis.

It is very clear that financial crisis is actually crisis of market. The product which has been produced are on very slow sale. The crisis is selling problem of products. How it occurs, I have already mentioned in my previous post.

Here I want to give some suggestion to resolve it. Current system of our world is capitalist system. Capitalist system by its nature produced the product for sale not for use in the conditions the contradictions comes with financial crisis.

Capitalist systems produced the product for market and earn profit but the profit has not been distribute as publicly. The profit goes in the single hand. The contraction creates the gap in society and market in both.

In the one hand we see the money and money but on the other hand only the need. The persons who have money, have no need to use all the things which has been produced. In the other hand the person who have need, money is not there to buy the product.

We know all the money is the equal of all the products of world or a nation. The money is exchange value in my previous post as I mentioned. Here the money distribution is not same with the productions due to gaining profit. In this conditions the production of products accumulate in one place and the money became capital on that place automatically.

I want to say if we produce the product for human society not for market then the problem of financial crisis will solve by itself.

The human society run under a system and currently it is in market system. If we make it social system and people energy work for human being needs fulfillment then it will remove financial problem automatically.

I am talking about financial problem but the problem creates by a system not a person so, the system if change, the financial problem remove automatically.

Financial Crisis Analysis

Today, we are facing now financial crisis in all over world. I think it is better to introduce about financial crisis at first. In my point of view financial crisis is the stage of capitalist system. The crisis comes time to time in the system and it is not new. We know, 1929 financial crisis was world’s biggest crisis and after that we face two world war to reduce the crisis. You will think I am talking about war and it is not related to financial crisis. But it is not true. Basically, war comes in the stage of crisis.

At first, we should discuss about capitalist system because the crisis has been produced by this system. It is simple every state has system to run that. Currently in the capitalist state what is the system to run the state we will see here. I have already said it is not new financial crisis in the system because every after every 10 years we face the crisis and after some time we forget all the things.

I think here should discuss about capitalist system something. Capitalist systems is different from its all previous system because it runs on money and capital. Now, the question is what is money? Money is nothing but a mediator. It is only exchange value. Suppose, we have a product A and money B then we can exchange from each other if the value is same.

To run every system and every thing basic is productions and products. The basic things is product and money is secondary thing which runs as exchange value. But in the capitalist systems the capital ruled over the production. Here creates all the problem because capital runs but the product remains constant in the situations we face some times inflations and some times crisis.

Now, we will see how the production increase and the sell of products goes in down in the system. The product has been produced for market not for people uses in priority. For example, if we are not able to pay a lump-sum for a product we can’t buy however the product after some times will be diminish. But the run market the product will not be sold.

It is the basic laws of production in the capitalist system. Now, we will discuss about circulation systems. In the circulation system the product comes in market but the money doesn’t come with that in market to buy the product. For example, in a company a labour work 8 hours and produced 100 rupees product but after the 8 hours he get only 20 rupees as a labour value. In this condition 80 rupees goes in the pocket of capitalist. We can assume that if the capitalist spend 40 rupees more to buy the row material, labour, machine etc. however he has still 40 rupees in his pocket. In this conditions in the market the product has been sold only the rupees of 60 and product of rupees remain in the store of capitalist. In this cycle the production accumulation became higher and crisis comes itself.

The capitalist system in this situations use the financial loans to face the problem which we can see today with the banks. Banks are trying to give more and more loans to the consumer. What is the reason behind it? They want to sell their product and want to capture the future saving of the people. I have already written about it with the topic of loans – killer of people future savings.

Lastly, the capitalist system can’t face the problem forever and can’t remove the financial crisis forever because the cycle of capitalist system is very bad. We can say the current scenario of the India. From the 2006 to 2008 the market was on boom because people got the loans and bought the product which was already produced before production of that.

People were thought that India is growing and market is in boom but what about today’s scenario. The market is in its real conditions and all the growth remain same of 2005. Actually, it was not growth it was the boom of capitalist system by the loans. Actual, production was remain constant then how a country can develop and growth. Only the consumptions was developed not production that is why after 2 years again we are facing the problem.

I think it is the analysis of financial crisis in the term of capitalist system. Now, from here we can deal what can be better options to escape the financial crisis.

I will write that in my next post with some example.

Loans – Killer of People Future Savings

1st we have to understand about the loans. A loan is a type of debt. It is sum of borrowed money which is general repaid with interest.

Next from where we get the loan? Loans are provided by lender or broker for a time period with some interest.

History of loans shows that some people take over the resources of social property and became a rich persona. All the history is evident of its. The people who captured on the resources started exploiting the people who had nothing to eat and live.

From here the concept loans came. It is basically come with the capitalist system because the system runs on capital. Basically it runs on accumulated capital.

With the development of industries the goods produced exceedingly. In this situation the accumulated goods were exceeded and crisis comes in economics.

We can see the recent scenario of Indian share market. The Sensex was started from about 8 or 9 thousands last year and this year reached over 20000.

People were happy that they are developing and their country is going to be world’s imperialist power. But all are only a showcase.

The real things were crisis of market. Accumulation of capitalist system reached in higher position in 1 year. All the things were not related to production but all things were related speculation and share market.

Banks provides money as a loan to people and people became a big consumer of market and all the products were sold very fast. But after this all the things became normal. Many banks announced their bankruptcy and now in the recent scenario all the banks trying to close their business.

Loans are given by banks as back support to sell the products of capitalist and they captures people future savings which is taken as interest by banks.

This was the thought about the loans that is why said, “Loans – Killer of People Future Savings”.