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The Effect Of Financial Leverage On Company's Performance

By Edited Jun 7, 2016 0 0

Financial leverages


Since a company may not be able to raise all funds which its required internally, this will make the company appeal or call for additional and external financing. That means the capitalization of the firm would be incorporated both internal generated  funds and external funds, external funds could  comprise of loan both short and long term loan bonds.

Financial leverages which is the subject matter of this study has to do with  external generation of funds for the company to expand it market volume and generation of profit which is the primary aim of every firm. The same time maximization of the shareholder wealth and welfare. Financial leverage is also gearing or trading on the equity leverage as the term implies involves the case of borrowed funds to act as a fulcrum to raise profit rate on a common stock to a level higher than be reached without its uses. Usually, different financial structure exists in the capital market.

There are various ways investors put or invest their money mainly through preference share, ordinary share, bonds and long term loan is also a source which investor use to finance a firm because when a firm depends on one of the above structure it does not have ability to enjoy the advantage of the financial structure. Shareholder increase the value of their share with market standard or the level of production of the company because that help the shareholder to know or have confidence of where they are investing the money. This means, the level of activities that can take place in a firm depends on the level of activities that goes on in the economy because the economy have a great effect on the activities of these firm especially those that are finance by the above various financial institution.

Firm: Is a business organization that carries on production under one management.
Finance:  To provide money for a project.
Leverage: The force applied to a level.
Maximize: To increase something as much as possible.
Acquisition: The action or process of acquiring something.
Manufacture: To make goods on large scale using machinery.
Fund: Sum of money saved or made available for a particular purpose.
Investor: A person or an organization that invested money.
Capitalization: To convert possession into capital or to provide capital for a company.
SYSTEM OF RESEARCH : THE USE OF FINANCIAL RATION: Ratio analysis is employs in financial data taken from the firms balance sheets and income statements and permits the changing of the various firms history and the evaluation of their present position. The ratio gives a trend analysis of the firm. The leverage ratio are used to judge the long term financial position of firm. It measures the extent to which the firm has been financed by debt and they also indicate that funds provided by the firms creditors. Firms with low leverage ratio have less risk of loss when the economy is in a down turn but they also have expected returns when the economy booms.Conversely, firm with higher-leverage ratios runs the risk of large losses but also have change of gaining.

TOTAL DEBT/TOTAL ASSET RATIO: This ratio is generally called debt ratio of  debt to capitalization ratio and it measures the percentage of total funds provided by creditors. It expresses the relationship between the total debts of a firm and the total resources available to that firm.

Total Asset : A low debt ratio of about less than 20% may mean that management is not dynamic enough in financing the business out of loanable funds and conversely a very high debt cover (firm 5% and above may be proof of very risk of higher speculating financing practice. The moderate ratio is preferred because the level of risk involved is reduced and thus a cushion against losses is created.

TOTAL DEBT/EQUITY RATIO : This ratio is also known as debt-to-network ratio and measures the amount of total debt in relation to the investment of the owner of the business.
It is express as: TD
Total debt = Equity shareholders.
The higher ratio shows that claims creditors are greater than those of owners and unfavourble from the firm point of view. A low ratio implies however a great claim of owners than creditors. The situation, from the point of view of creditors represents a satisfactory capital structure since a high proportion of equity provides a large margin of safety for them. In general, firms endeavour to maintain debt. Equity ratio not exceeding 1:1.

TIME INTEREST EARNED: The times-interest earned ratio is also called the average ratio. It measures the extent to which earnings can decline without resultant financial embarrassment to the firm because of inability to meet annual cost.Failure to meet this obligation can bring legal action by the creditors, possible resulting in bankruptcy.
The ratio is determine as follows:
Time interest  = Income before taxes – Interest Interest



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