financial leverage


Also found in: Acronyms.

Financial leverage

Use of debt to increase the expected return on equity. Financial leverage is measured by the ratio of debt to debt plus equity.

Financial Leverage

1. To use debt to finance an activity. For example, one usually borrows money in the form of a mortgage to buy a house. One commonly refers to this as leveraging the house. Likewise, one leverages when one uses a margin in order to purchase securities.

2. The amount of debt that has been used to finance activities. A company with much more debt than equity is generally called "highly leveraged." Too much leverage is often thought to be unhealthy, but many firms use leverage in order to expand operations.

financial leverage

The extent to which interest on debt magnifies changes in operating income into even greater proportionate changes in earnings after taxes. Financial leverage magnifies increases in earnings per share during periods of rising operating income but adds significant risks for stockholders and creditors because of added interest obligations. Compare operating leverage. See also debt management ratio, debt-to-equity ratio.
Case Study Financial leverage results from utilizing debt to finance assets. The greater the ratio of funds contributed by creditors compared to funds contributed by stockholders, the greater a firm's financial leverage. Financial leverage magnifies changes in net income compared to changes in operating income. For example, financial leverage might cause a firm's reported net income to increase by 30% when operating income increases by 20%. Without financial leverage the 20% increase in operating income would produce an equal percentage increase in net income. The magnification operates both upward and downward, which means stockholders benefit from financial leverage when times are good and operating income is increasing but their investment in the firm can be at substantial risk when times are bad and operating income is falling. In late 2001 Italian automaker Fiat announced a restructuring intended to reduce financial leverage by halving the firm's debt of nearly €7.5 billion. As part of the restructuring Fiat said it would sell €2 billion of assets, undertake a €1 billion rights offering to sell new stock, and issue $2.2 billion in bonds exchangeable for the firm's holding of General Motors Corporation common stock. The restructuring package was intended to increase equity at the same time it reduced the firm's debt, both of which would decrease financial leverage and dampen fluctuations in net income. At the time, Fiat was struggling as Europe's fifth-largest automaker.
References in periodicals archive ?
To study the impact of financial leverage on average cost of capital,
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Exhibits 1 and 2 summarize income statement and balance sheet information, respectively, for Salton over the period 1991 through 1999 and provide the necessary information for the financial leverage calculations.
However, just analyzing this piece of the financial leverage component fails to tell you whether management was able to realize favorable leverage or not.
Best as operating leverage would be excluded fully from the calculation of consolidated financial leverage, unless the tolerance level is exceeded.
It is expected that FNT will support the growth of Sedgwick through acquisitions, and consequently, future financial leverage will remain a key rating issue.
The proposed offering will bring Selective's debt to total capital ratio to approximately 24%-28%, which is within Fitch's financial leverage expectations.
Fitch's rating actions are based on AEL's improved balance sheet including declining financial leverage at the holding company level and improved risk-adjusted capital at the operating company level.
The basis for the Positive Rating Watch is both the strong operating performance at the underwriting subsidiaries level and the expected moderate consolidated financial leverage following the completion of the proposed transaction.
Further, the timing of the acquisition comes as the title insurance industry enters a downturn, and would weaken LFG's balance sheet by adding to financial leverage and significantly increasing intangibles, which lowers the quality of capital.
Fitch's ratings reflect RLI's consistently strong underwriting profitability, moderate financial leverage, and strong earnings-based and cash basis interest coverage.
These rating affirmations reflect White Mountains' conservative financial leverage and financial flexibility, as well as the steps it has taken to improve earnings sustainability at its various operating entities.

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