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what is meant by financial leverage? How does financial leverage influence the level of financial risk?

what is meant by financial leverage?

How does financial leverage influence the level of financial risk?

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Financial leverage refers to the use of borowed money or debt in an entity's capital structure for business. It is often measured using the financial ratio whose formula is (Earnings before interest and tax/ Earnings before tax)

Financial leverage influences risk as use of debt in capital structure increases the burden of compulsory interest payments for the company. During periods of good performance by the company, this might not seem like an issue, but during difficult times this burden could be too much for the company and even in extreme circumstances, might lead the company to run out of business. Hence, it increases the risk of the equity shareholders, thereby influencing financial risk.

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