What Is the Financial Leverage Ratio?

A financial leverage ratio measures the rate of change of earnings per share to a change or variation in operating profit or operating profit of the business, in percentage terms.

The financial leverage ratio between two consecutive economic scenarios or periods of a company is measured as follows:

Financial leverage = (Var.% Of net result) / (Var.% Of UAII).

What is the degree of financial leverage?

The degree of financial leverage is abbreviated GAF ​​or DFL by the acronym for ” Degree of Financial Leverage “. It is a ratio that measures the percentage change in net income or earnings per share with respect to the percentage change in operating income or earnings before interest and taxes (UAII or EBIT).

The calculation of the degree of financial leverage obeys the following formulas:

GAF = (Change% in EPS) / (Change% in EBIT) or also

GAF = EBIT / (EBIT-Interest)

What is positive financial leverage?

We will obtain positive financial leverage when the net earnings or earnings per share growth in greater proportion than the operating result of the company.  

On the other hand, an unfavourable or negative financial leverage takes place when the operating profits decrease and cause the net result to contract in a greater proportion.

A company or an investor will achieve favourable financial leverage when the return on its investment is higher than the interest cost of the foreign capital invested.

Related: Types of Leverage, Examples and Interpretation

For example, if you borrow from a popular credit company at 10% per year, take the funds and invest them in your business, generating a return of 12%, you will have a positive financial lever.

Conversely, you will have unfavourable or negative leverage when your business does not earn as much as the cost of the debt you incur.

What is meant by combined leverage?

Combined leverage involves “combined risk” or business risk. It is the joint action of leveraging a business in operational and financial terms.

If a business due to the commercial line or due to its nature assumes a high operational risk (that is, it has high fixed costs), it is logical to try to manage a low financial risk.

On the other hand, if the operational risk is low, financial management can manoeuvre with high financial leverage.

The objective will be to maintain combined leverage and, therefore, a total risk within a tolerable limit that covers expectations of creditors and investors.

What is the leverage?

Leverage ” is the English term for leverage.

Some experts also consider “ Leverage ” as a leverage threshold, a maximum limit of costs and fixed charges allowed after which the risk of insolvency increases and the burden of operating costs and debt expenses is such that it exerts an unfavourable influence on business results.

What is leverage 1 100?

Leverage 1:10, 1: 100, and generally up to 1: 400, is the nomenclature for leverage Forex, CFD and similar investments.

They are a practice by some agents in trading in CFDs or market halves when they promise to put $ 100 in total investment for every dollar you choose to invest with them.

Related: What Is Leverage in Finance: Leverage Definition and Concepts

It is a lever practice that increases the invested capital and returns a result on the expanded investment.

However, since it is a bet, it is subject to speculation and the return or result may be favourable or unfavourable. Therefore, just as you can expand your profit, you can also multiply losses.   

Other contexts where leverage applies

We have always talked about leverage in terms of finances, although the concept of leverage can go beyond the money or profits of a business.

In any context of life, when you reach a foothold and thereby achieve results that exceed expectations, you are applying leverage.

So “leverage” will be present when you lean on e-commerce platforms to sell your products when you use the fully established companies’ marketing and logistics channels.

There is also talk of “leveraging” when you subcontract talents or receive the support of an influencer to promote yourself on the networks, etc.  

Marketing leverage

When you lean on the resources of others to increase or improve your strength or results, you are leveraging yourself.

Leverage in marketing is done when you rely on the resources, models and tools of proven systems or highly recognized agencies.

A marketing affiliate is a form of leverage. Companies build networks to promote their products, and those seeking referrals earn endorsement and royalties from a parent company.

The franchise system can also be seen as a form of leverage, when you hire a franchise, you are leaning on a proven business model.

network marketing ” and ” marketing cooperative” are forms of mutual leverage. Companies like Uber or Airbnb lend a platform and in return use the facilities and resources of others in association to impose their business models.

What is leverage in trading?

BBVA offers us an explanation of the leverage in trading.

The trading leverage is a “facility” or option offered by online agents or brokers for investors to amplify their investment and, with it, the result.

For BBVA, “ trading with leverage” is entering the market with a much higher position than what you actually count, increasing the possible profit but also the associated risk.  

Accounting leverage

In accounting and more specifically in the context of financial statement analysis, leverage is an index that measures debt.

It is built with the quotient or division between total liabilities and assets. Determine the portion of assets that are being financed or covered with third-party funds.

Leverage through logistics

When you use the logistics resources of specialized third parties and thereby minimize the investment of your own resources achieving the same or better results, you will be leveraging logistics.

  • Supply chain management
  • Changes in the level of customer service
  • Traceability systems  
  • Inventory management
  • Innovation and differentiation tactics
  • Market Segmentation.

These may well be seen as “key points” for achieving leverage.

These are aspects in which, with little investment or little effort, high-impact changes or remuneration are achieved. So get excited about using leverage in the business you want to start or the project you currently have.

I close the post with the same phrase with which we started: “look for a foothold and raise the world.”

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