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.

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.

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.