The leverage effect in financial management mainly refers to the existence of specific expenses (such as fixed costs or fixed financial expenses). When one financial variable changes in a small range, another related financial variable will change in a large range.
The essence of financial leverage effect is:
Because the profit rate of enterprise investment is greater than the interest rate of debt, part of the profit from debt is converted into equity capital, which makes the profit rate of equity capital rise.
If the profit rate of enterprise investment is equal to or less than the interest rate of debt, then the profit generated by debt can only or not make up for the interest required by debt, and even the profit obtained by using equity capital is not enough to make up for the interest, so we have to reduce equity capital to pay off debt, which is the loss caused by the negative effect of financial leverage.
Extended data
The leverage effect in finance includes operating leverage, financial leverage and compound leverage.
1, operating leverage refers to the leverage effect that the change of earnings before interest and tax is greater than the change of production and sales due to the existence of fixed costs.
2. Financial leverage refers to the leverage effect that the change of earnings per share of common stock is greater than the change of earnings before interest and tax due to the existence of debt.
3. Composite leverage refers to the leverage effect that the change of earnings per share of common stock is greater than the change of production and sales due to the existence of fixed production and operation costs and fixed financial expenses.
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