![]() ![]() ![]() The debt obligations can include interest payments, principal amount and other fixed liabilities. These ratios are also known as ‘Debt ratios’. That is exactly how leverage helps a firm increase return on shareholder’s equity.Financial Leverage Ratio refers to certain ratios which measure a businesses’ ability to meet its long-term debt obligations. So you see that you were able to use leverage as a ‘lever’ to increase the return on equity from 10% to 30%. Now your return on equity becomes 30% ($60 / $200). Your income comes down by $40 (as you pay interest on the loan you get from your friend) to $60. So you need to put in only $200 from your pocket. Now assume that your friend loans you $800 and the interest that you have to pay him amounts to $40. The after-tax cash benefit you will receive through rent is $100. ![]() Let us assume that you have to purchase a house worth $1,000 which you intend to rent out. To explain this concept, let us talk about a slightly different scenario. To understand this ratio, we need to understand how leverage affects return on equity for a firm. It basically tells us how effective the firm is in using leverage in its capital structure. Definition - What is Financial Leverage Index?įinancial Leverage Index is a solvency ratio that can help us find out how well a company is using leverage to increase return on its equity. You will learn how to use its formula to examine a company's capital structure. This is an ultimate guide on how to calculate Financial Leverage Index with detailed analysis, interpretation, and example.
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