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Financial Analysis

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In What Way Is Financial Leverage Similar To Physical Leverage?

Leverage in all its forms involves the process of magnification. Financial leverage and physical leverage are used to produce some magnified result. However, the differences are in what is magnified- income versus physical force, and what is employed as the lever- fixed costs (fixed amounts) versus a mechanical device. For example, at a proper fulcrum point, 200 pounds can be used to lift 500 pounds (physical leverage). The leverage ratio is, thus, 500/200 = 2.5. Likewise, an equity of $5 million can be used to buy $12.5 million worth of property. The leverage ratio is 12.5/5 = 2.5.


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