Financial leverage can be terms as the use of fixed charges sources of funds, such as debt and preferences capital along with the owner equity in the capital structures. The use of the terms trading on the equity is derived from the fact that it is the owner equity (capital) reserved by equity share capital and resources and surplus that is used as a basis to raise debt and preference capital that is the equity that the preference capital is traded upon. in business the higher the risk the higher the return when funds are introduce into a business more than it suppose to be. So many people tends to imply on the same concept of leverage as the uses of debts financing in a company while using the common stock equity as protection for creditors. In order to increase the profit level of the shareholders of the company. It is intended to earn more or less on the fixed charged fund than their cost.
EQUITY FINANCING : Referred to a situation where by the company raised fund within (internally) the company in order to increase the volume of its production or the output as well as the profit of the company. Equity finance is very important, preferable to the company .the holder of equity finance are considered to be the ultimate risk bearer in the business. This is because they receive their own share of the income (profit) after all prior claims have been settled.
The following are the sources of equity finance for a liability company:
i. The issued ordinary holder capital.
ii. The founder share capital
iii. The preference share capital
iv. Retain profit and reserves.
The above mentioned source gives a company confidence to expand the volume of its production
DEBT FINANCING : These are the various ways that a company is finance by outside body or source different from the equity share, in some cases the same person that owned an equity share may have debt finance. The company owner of this classes of share are first of all considered at the end of the period before an attention can be given to any other source of finance (equity). In most case interest, are paid on such capital irrespective of the fortune of the company i.e. whether the firm make profit or not at the end of the period (year).
The following are some source of debt finance.
i. Secured debenture stock with maturity data.
ii. Naked debenture stock with maturity data.
iii. Bank loan/overdraft.
iv. Amount due to the trade credit.
The above mention sources play a very important role in a company because, it's believes that when a person or company wants to obtain a large amount of money and a long term loan debt finance is considered to be reliable at any time provided the company have it registered document (the prospect, the memorandum and the articles of company in securing loan from the bank or any other source.
INTERNAL FINANCE : This refer to fund used by a company to finance itself, that is its provide itself funds internally. Internal source constitute a major source of fund for a firm expansion.This explains why managers of firm look within before looking beyond the firm for necessary fund.
The following are the source of internal fund or finance.
i. Retained earning.
ii. Provision for tax
iii. Provision for depreciation
EXTERNAL FINANCE : Due to a large amount which a firm financing is required, a large amount of funds or finance which cannot be hardly raise from internal source alone. There is need to look beyond the internal sources for necessary funds both for starting the business and for eventual expansion also.
The following are the source of external source.
These sources are considered to be reliable to firm because it provide a source of help to the firm when the situation arised.