Financial leverage is a procedure for indebtedness to a banking institution for a company or an organization in order to finance their investments. The purpose of this loan is to make the investment profitable so that it can repay the amount of financing. An organization’s financial leverage is determined by relating its net debt to its own capital.
Synonyms of Financial Leverage:
The term financial leverage has several synonyms. We can then meet the term under the following names:
-Rate of return on economic assets
Etymology of Levier
The word “lever” derived from the word “lever” comes from the Latin “levare” which means “to lift”. The word “Financial” is the derivative of “finance”, which means “money”.
Useful Terms Related to Financial Leverage
Definition of Financial Leverage
Financial leverage is the fact that a company or another economic entity uses a loan from a banking institution to guarantee their profitability thanks to the leverage effect.
Definition of Leverage effect
The effect of financial leverage is a mechanism that serves to increase profits and losses tenfold. The financial markets present many products which have a leverage effect such as warrants. The latter are expressed at equivalent investment by gains or losses which are higher than allowed by their underlying such as equities.
In financial management, the leverage effect also acts as an amplifier like the operational leverage which represents the elasticity of the result compared to the turnover.
Definition of Financial leverage ratio
The leverage ratio is the indicator of the capacity of shareholders’ equity to repay all of the outstanding debt. The leverage ratio is calculated by dividing total liabilities by total equity. Its value can change a lot without becoming unhealthy.
However, a low leverage ratio can mean a mature operation not looking to grow or innovate. A high leverage ratio, on the other hand, indicates that a company that has used financial leverage is looking for growth opportunities. However, it is exposed to great financial risks. With these explanations on the lever ratio, you will be able to better understand its principle in order to better exploit it.
Definition of Financial Leverage in Crypto currency
In crypto-currency, financial leverage is a margin trading technique which consists in increasing one’s investment capital by resorting to borrowing on an exchange platform. It is a very risky move with likewise great chances of losses.
Financial Leverage Effect in Forex – Definition
Financial leverage in Forex is a system that allows you to trade with position sizes larger than the amount available in your account. The effect of financial leverage in Forex can be a way to leverage your investment. However, using leverage does not always result in gains. The risks of loss are also high.
What is Leverage in Real Estate – Definition
In the real estate, leverage is a concept consisting in resorting to the debt for a short time in order to increase one’s an investment capacity. Therefore, the increase in its long-term capital, in other words, it is a self-financing technique which making it possible to strengthen the profitability.
Financial Leverage Club Effect – Definition
The club effect is also called the snowball effect or boomerang effect. The club effect refers to when the interest rate exceeds the rate of inflation. This will turn the loan into a risky bet because it will cost more and could lead to serious financial difficulties.
This phenomenon has already taken place on a large scale during the 1980s. For a company, the mass effect takes place when the rate of profit is below the interest on the debt. In this situation, financial profitability is said to be negative.
What is the Calculation of Financial Leverage?
The calculation of a financial leverage effect consists in calculating the amplifying effect of the leverage. It is used to assess the financial risks taken by the investor. For example, a company has for example a profitability of 15%. A debt with an interest
rate of 8% is therefore interesting. But for a rate of 20% for example, the consequences could be disastrous as it goes into debt. This is the principle of financial leverage. It presents a positive or negative amplifying effect, thus explaining the financial risk.
Financial leverage is an important concept to know in order to assess the possibility of making a return on your investments. In financial markets, leverage is a way of taking positions with the hope of making substantial profits, but with great risks. Big investors like Warren Buffet use a little leverage to increase the return on their investments, to the point that people have given that leverage a name: Warren Buffet leverage.
It is therefore wise to take into account the impact of this type of debt, whether for economic players, or for individuals who want to invest in the stock market or who wish to make financial investments.