What Is The Impact Of Financial Leverage On Return And Risk?

Financial Leverage:
Financial Leverage in the extent or degree to which the company's total capital is composed of Debt.
Financial leverage of Debt Financing increase overall risk and return of the company. Debt financing impact on returns of a change in the extent to which the firm's assets are financed with borrowed money. Financial Leverage magnifies risk and adds volatility to returns. The higher the leverage, the more risky the company becomes. This is because a company having higher leverage will have to pay interests which is an extra expense going from the operating cash flows
Increase in Returns:
• Financial leverage increase in Returns or ROE (Return on Equity) of the firm. EBIT is greater then Interest cost for financial leverage then it is good for the firm. Because its mean firm is generating profits by the use of Debt it takes resulting in positive cash flows.
• When debt is introduced in capital structure of firm then the number of share holders is less and if company makes profit form this debt then this debt is distributed in lesser number of peoples. This increase in per share resulting in Increased ROE.
Increase in Risk:
• Debt contain fixed interest regardless of company is making any profit or not this increase chance of Losses. Can cause bankruptcy

Financial leverage is basically the degree to which a business is utilizing the money it borrowed from outside sources. It has a significant impact on return and risk. Highly leveraged firms are at a higher risk of bankruptcy if they fail to make payments on debt, that is why it is not considered good. Also, It has its benefits in terms of return to the shareholders. As it increases the return on shareholder's investment and also brings tax advantages to the company.