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382 Corporate Finance BRILLIANT’S

Significance of Financial Leverage \$m`ZopÝe`c brdaoO H$m _hÎd
Financial leverage is used to plan the ratio \$m`ZopÝe`c brdaoO H$m Cn`moJ S>oãQ> Ed§ BpŠdQ>r
between debt and equity so that earning per Ho$ AZwnmV H$m {ZYm©aU H$aZo _| {H$`m OmVm h¡ Vm{H$ à{V
share (EPS) is improved. The significance of fi- eo`a Am` (EPS) H$mo ~‹T>m`m Om gHo$Ÿ& \$m`ZopÝe`c
nancial leverage can be explained in the fol- brdaoO Ho$ _hÎd H$mo {ZåZ{b{IV {~ÝXwAm| H$s ghm`Vm go
lowing points: g_Pm Om gH$Vm h¡…
(i) Planning about capital structure: The (i) H¡${nQ>c ñQ´>ŠMa H$s `moOZm ~ZmZm… H¡${nQ>c
capital structure is concerned with the raising ñQ´>ŠMa H$m AW© h¡ cm±J-Q>_© \$m`ZoÝg H$s ì`dñWm Ho$
of long term funds from shareholders and long {b`o B{ŠdQ>r Ed§ S>oãQ> Ho$ ~rM H$m AZwnmV V` H$aZmŸ& EH$
term creditors. A financial manager is required \$m`ZopÝe`c _¡ZoOa H$m `h Xm{`Ëd h¡ {H$ dh H¡${nQ>c
to decide about the ratio between fixed cost ñQ´>ŠMa _| S>oãQ> d BpŠdQ>r Ho$ AZwnmV H$m {ZYm©aU Bg
funds and equity share capital. Financial lever- àH$ma H$ao {H$ à{V eo`a Am` A{YH$V_ hmo gHo$Ÿ&
age helps in determining an ideal capital struc- \$m`ZopÝe`c brdaoO Bg_| ghm`H$ hmoVm h¡ Vm{H$ EH$
ture. AmXe© \$m`ZopÝe`c brdaoO {ZYm©[aV {H$`m Om gHo$Ÿ&
(ii) Planning about profit: The degree of (ii) bm^ Ho$ gå~ÝY _| `moOZm ~ZmZm… \$m`ZopÝe`c
financial leverage affects earning per share. If brdaoO H$s gr_m à{V eo`a Am` H$mo à^m{dV H$aVr h¡Ÿ&
the profitability of a concern is increasing then `{X {H$gr ì`dgm` H$s bm^Xm`H$Vm, ñWm`r bmJVm| H$s
fixed cost will help in increasing the availabil-
VwbZm _| A{YH$ h¡ Vmo BpŠdQ>r eo`ahmoëS>g© H$m bm^ ~‹T>oJmŸ&
ity of profit for equity shareholder. In this way,
Bg àH$ma, \$m`ZopÝe`c brdaoO bm^ H$s `moOZm ~ZmZo _|
financial leverage is important for profit plan-
ning. ^r ghm`H$ hmoVm h¡Ÿ&

Limitations of Financial Leverage \$m`ZopÝe`c brdaoO H$s gr_mE±
Financial leverage suffers from certain \$m`ZopÝe`c brdaoO H$s Hw$N> gr_mE± h¢ Omo Bg
limitations which are as follows: àH$ma h¢…

(i) Useful for companies having stability (i) pñWa Am` dmcr H$ån{Z`m| Ho$ {b`o hr Cn`moJr…
of earnings: Calculation of financial leverage \$m`ZopÝe`c brdaoO Ho$db CÝht H$ån{Z`m| Ho$ {b`o Cn`moJr
is helpful only to the companies having stable h¡ Omo ñWm{nV hmo MwH$s h¡§ VWm {OZH$s Am` {Z`{_V h¡Ÿ&
and regular earnings. This is so because inter-
est on debentures is a fixed burden on the com- BgH$m H$maU `h h¡ {H$ {S>~oÝMg© na ã`mO, H$ånZr na
pany and a company having irregular income EH$ ñWm`r ^ma h¡ Am¡a {OZ H$ån{Z`m| H$s Am` _|
can not pay interest on its borrowings during A{Z`{_VVm h¡ do _ÝXr Ho$ Xm¡amZ S>oãQ> na ã`mO XoZo _|
slack. naoemZr H$m AZw^d H$a gH$Vr h¢Ÿ&
(ii) Increases risk and rate of interest: An- (ii) ã`mO H$s Xa Ed§ Omo{I_ ~‹T>Zo H$m ^`… Q´>oqS>J
other limitation of trading on equity is on ac- Am°Z B{ŠdQ>r H$s EH$ Am¡a H$_r `h h¡ {H$ O¡go-O¡go S>oãQ>
count of the fact that debts increase risk as well
~‹T>Vm h¡, ã`mO H$m ^ma ^r ~‹T>Vm h¡Ÿ& Eogr pñW{V _| {~Zm
as rate of interest on subsequent loans. There- {gŠ`y[aQ>r Ho$ H$ånZr H$mo S>oãQ> boZm _wpíH$b hmoVm h¡ AWdm
fore, it becomes difficult for the company to ob-
tain further debts without offering extra secu- ã`mO H$s Xa ~‹T>mZm n‹S> gH$Vr h¡Ÿ&
rities and higher rate of interest. 