Financial Leverage Meaning, Ratio, Calculation, Example

Where EBIT (Earnings Before Interest and Taxes) is divided by the Interest Expense. This ratio shows how easily a company can pay interest on outstanding debt. A higher ratio indicates stronger ability to cover interest payments. The use of financial leverage has many drawbacks that borrowers must consider before formally committing to a lending agreement. The core objective of a corporation is to maximize shareholder wealth, per financial management theory. Financial leverage refers to a corporation borrowing capital from lenders to meet its recurring, operational spending needs and capital expenditures (Capex).

For instance, a Debt-to-Equity Ratio of 2 means that the company has twice as much debt as equity, suggesting a more aggressive financing strategy. The influence of financial leverage on Earnings Per Share (EPS) is profound, shaping the way investors perceive a company’s profitability and risk. EPS, a key self employment tax indicator of a company’s financial performance, is calculated by dividing net income by the number of outstanding shares. When a company employs financial leverage, it uses borrowed funds to invest in growth opportunities, aiming to enhance its earnings.

There are three major types of leverages financial management focuses on – financial leverage, operating leverage, and combined leverage. However, financial leverage meaning can simply be understood as companies and individuals using borrowed funds to invest in assets that increase returns or profits. The goal of the borrower is to make sure that the profits generated by the newly acquired asset generate more earnings than the interest on the borrowed amount. The debt-to-equity (D/E) ratio measures the amount of debt a business has relative to its equity.

Financial Leverage for Personal Finances

For example, depending on the Forex broker a trader uses, they could request orders of 500 times the size of their deposit. That discrepancy between cash and margin can potentially increase losses by huge orders of magnitude, leaving it a strategy best left to very experienced traders. While leverage in personal investing usually refers to buying on margin, some people take out loans or lines of credit to invest in the stock market instead. Leveraged ETFs are self-contained, meaning the borrowing and interest charges occur within the fund, so you don’t have to worry about definition explanation and examples margin calls or losing more than your principal investment. This makes leveraged ETFs a lower risk approach to leveraged investing.

Debt-to-equity (D/E) Ratio

You’re using all debt, including short- and long-term debt vehicles when you calculate this ratio. Dive deeper into your financial education and explore how leveraging can work for you. One of the essential offerings of the banking suite is the current account.

A suite of financial ratios referred to as leverage ratios analyzes the level of indebtedness a company experiences against various assets. The two most common financial leverage ratios are debt-to-equity (total debt/total equity) and debt-to-assets (total debt/total assets). Financial leverage is the practice of borrowing money, investing the funds, and planning for future returns to be greater than debt servicing costs. In this way, a company can use debt to generate more revenue, though at a risk. Leverage is often used when businesses invest in themselves for expansions, acquisitions, or other growth methods. It’s also an investment strategy that uses various financial instruments or borrowed capital to increase the potential return on an investment.

Why companies may choose leverage

Understanding these risks is crucial for maintaining long-term financial health. Companies may experience increased earnings, but they also face the possibility of significant losses. In the case of asset-backed lending, companies use previous assets as collateral for the loan. For a cash flow loan, the creditworthiness or the credit score of the company backs the loan. In this example, you leveraged your $1,000 to buy more of Tom’s opportunity than you could have afforded on your own. Financial leverage allows the existing shareholders to keep their current level of control over the company as they can raise funds by taking out loans rather than issuing new equity.

They can raise these funds by debt financing, which means borrowing money through loans, bonds, or other debt instruments. The operating leverage formula measures the proportion of fixed costs per unit of variable or total cost. When comparing different companies, the same formula should be used. This indicates that the company is financing a higher portion of its assets by using debt. Stock investors and traders can calculate key financial ratios such as debt-to-equity, interest coverage, and debt-to-asset ratios, to evaluate a company’s fundamentals.

Understanding Financial Leverage: Types, Calculations, and Impact

Some investors like a bit of risk and see leverage as an opportunity. The Degree of financial leverage is calculated by dividing the change in the percentage of a company’s earnings per share by its earnings before interest and taxes. The main goal of calculating this degree is to understand the sensitivity of a company’s earnings how do i write a business plan for a nonprofit organization per share. Suppose a company uses ₹10,00,000 of its cash and a loan of $90,00,000 to buy a new factory worth a total of ₹1 Cr. If this new factory generates ₹15,00,000 in annual profit, it means that it uses financial leverage to generate a profit of ₹15,00,000 on a cash investment of ₹10,00,000.

The financial leverage ratio is an indicator of how much debt a company is using to finance its assets. A high ratio means the firm is highly levered (using a large amount of debt to finance its assets). The aspect of financial leverage is significant since it empowers both individual investors and organisations to tap into investment opportunities that may surpass their existing cash reserves. Although this strategy entails a level of risk, it has the potential to foster business expansion, thereby generating additional employment opportunities and stimulating economic activity.

With the borrowed funds, RetailCo opens several new stores in strategically selected locations. The expansion allows the company to reach a larger customer base and increase its market share. As a result, RetailCo experiences a significant boost in sales and profitability. The leverage enables the company to maximize its growth potential and establish a stronger market position.

The companies using financial leverage have better profitability for shareholders than those using equity financing only. The increase in profitability of a company using financial leverage is higher than the increase in stock’s value or dividend. Yes, individuals can use financial leverage through loans or margin accounts when investing.

Individuals or businesses purchase assets or collect funds to build projects by borrowing money from private lenders or banks. Business owners get the opportunity to acquire capital or funds at short notice and are mostly helpful in business expansion. As a general guideline, the lower the financial leverage ratio, the less debt on the borrower’s balance sheet (and less credit risk). In a margin account, you can borrow money to make larger investments with less of your own money. The securities you purchase and any cash in the account serve as collateral on the loan, and the broker charges you interest.

A growth company may have a short-term need for capital resulting in a strong mid-to-long-term growth opportunity during acquisitions or buyouts. Consumers may eventually find it difficult to secure loans if their consumer leverage gets too high. Lenders often set debt-to-income limitations when households apply for mortgage loans. The financial leverage, in this case, has increased from 30.23% in 2014 to 34.05% in 2015. According to a mandate by RBI in 2019, the standard leverage ratio in India is 3.5%. If a company has a high debt-to-EBITDA, it means that the company has more debt than what it makes.

Next, they invest the whole ₹22,00,000 in an investment fund that has an annual return of 15% per year. If investments fail, you can be left dealing with substantial losses. You need to pay the bank $4,120 (the money you borrowed, plus one month’s interest).

It’s characterised by periods of high borrowing in an economy, which lead to price bubbles, followed by a deleveraging process and economic meltdowns, such as the global financial crisis of 2008. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing. The point and result of financial leverage is to multiply the potential returns from a project. Leverage will also multiply the potential downside risk in case the investment doesn’t pan out.

Posted: June 10, 2021 10:54 am


According to Agung Rai

“The concept of taksu is important to the Balinese, in fact to any artist. I do not think one can simply plan to paint a beautiful painting, a perfect painting.”

The issue of taksu is also one of honesty, for the artist and the viewer. An artist will follow his heart or instinct, and will not care what other people think. A painting that has a magic does not need to be elaborated upon, the painting alone speaks.

A work of art that is difficult to describe in words has to be seen with the eyes and a heart that is open and not influenced by the name of the painter. In this honesty, there is a purity in the connection between the viewer and the viewed.

As a through discussion of Balinese and Indonesian arts is beyond the scope of this catalogue, the reader is referred to the books listed in the bibliography. The following descriptions of painters styles are intended as a brief introduction to the paintings in the catalogue, which were selected using several criteria. Each is what Agung Rai considers to be an exceptional work by a particular artist, is a singular example of a given period, school or style, and contributes to a broader understanding of the development of Balinese and Indonesian paintng. The Pita Maha artist society was established in 1936 by Cokorda Gde Agung Sukawati, a royal patron of the arts in Ubud, and two European artists, the Dutch painter Rudolf Bonnet, and Walter Spies, a German. The society’s stated purpose was to support artists and craftsmen work in various media and style, who were encouraged to experiment with Western materials and theories of anatomy, and perspective.
The society sought to ensure high quality works from its members, and exhibitions of the finest works were held in Indonesia and abroad. The society ceased to be active after the onset of World War II. Paintings by several Pita Maha members are included in the catalogue, among them; Ida Bagus Made noted especially for his paintings of Balinese religious and mystical themes; and Anak Agung Gde Raka Turas, whose underwater seascapes have been an inspiration for many younger painters.

Painters from the village of Batuan, south of Ubud, have been known since the 1930s for their dense, immensely detailed paintings of Balinese ceremonies, daily life, and increasingly, “modern” Bali. In the past the artists used tempera paints; since the introduction of Western artists materials, watercolors and acrylics have become popular. The paintings are produced by applying many thin layers of paint to a shaded ink drawing. The palette tends to be dark, and the composition crowded, with innumerable details and a somewhat flattened perspective. Batuan painters represented in the catalogue are Ida Bagus Widja, whose paintings of Balinese scenes encompass the sacred as well as the mundane; and I Wayan Bendi whose paintings of the collision of Balinese and Western cultures abound in entertaining, sharply observed vignettes.

In the early 1960s,Arie Smit, a Dutch-born painter, began inviting he children of Penestanan, Ubud, to come and experiment with bright oil paints in his Ubud studio. The eventually developed the Young Artists style, distinguished by the used of brilliant colors, a graphic quality in which shadow and perspective play little part, and focus on scenes and activities from every day life in Bali. I Ketut Tagen is the only Young Artist in the catalogue; he explores new ways of rendering scenes of Balinese life while remaining grounded in the Young Artists strong sense of color and design.

The painters called “academic artists” from Bali and other parts of Indonesia are, in fact, a diverse group almost all of whom share the experience of having received training at Indonesian or foreign institutes of fine arts. A number of artists who come of age before Indonesian independence was declared in 1945 never had formal instruction at art academies, but studied painting on their own. Many of them eventually become instructors at Indonesian institutions. A number of younger academic artists in the catalogue studied with the older painters whose work appears here as well. In Bali the role of the art academy is relatively minor, while in Java academic paintings is more highly developed than any indigenous or traditional styles. The academic painters have mastered Western techniques, and have studied the different modern art movements in the West; their works is often influenced by surrealism, pointillism, cubism, or abstract expressionism. Painters in Indonesia are trying to establish a clear nation of what “modern Indonesian art” is, and turn to Indonesian cultural themes for subject matter. The range of styles is extensive Among the artists are Affandi, a West Javanese whose expressionistic renderings of Balinese scenes are internationally known; Dullah, a Central Javanese recognized for his realist paintings; Nyoman Gunarsa, a Balinese who creates distinctively Balinese expressionist paintings with traditional shadow puppet motifs; Made Wianta, whose abstract pointillism sets him apart from other Indonesian painters.

Since the late 1920s, Bali has attracted Western artists as short and long term residents. Most were formally trained at European academies, and their paintings reflect many Western artistic traditions. Some of these artists have played instrumental roles in the development of Balinese painting over the years, through their support and encouragement of local artist. The contributions of Rudolf Bonnet and Arie Smit have already been mentioned. Among other European artists whose particular visions of Bali continue to be admired are Willem Gerrad Hofker, whose paintings of Balinese in traditional dress are skillfully rendered studies of drapery, light and shadow; Carel Lodewijk Dake, Jr., whose moody paintings of temples capture the atmosphere of Balinese sacred spaces; and Adrien Jean Le Mayeur, known for his languid portraits of Balinese women.

Agung Rai feels that

Art is very private matter. It depends on what is displayed, and the spiritual connection between the work and the person looking at it. People have their own opinions, they may or may not agree with my perceptions.

He would like to encourage visitors to learn about Balinese and Indonesian art, ant to allow themselves to establish the “purity in the connection” that he describes. He hopes that his collection will de considered a resource to be actively studied, rather than simply passively appreciated, and that it will be enjoyed by artists, scholars, visitors, students, and schoolchildren from Indonesia as well as from abroad.

Abby C. Ruddick, Phd
“SELECTED PAINTINGS FROM THE COLLECTION OF THE AGUNG RAI FINE ART GALLERY”


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