Financial Leverage:

The use of long-term fixed interest bearing debt and preference share capital along with equity share capital is called financial leverage or trading on equity. The use of long-term debt increases magnifies the earnings per share if the firm yields a return higher than the cost of debt.

The earnings per share also increase with the use of preference share capital but due to the fact that interest is allowed to be deducted while computing tax, the leverage impact of debt is much more. However, leverage can operate adversely also if the rate of interest on long-term loans is more than the expected rate of earnings of the firm. Therefore, it needs caution to plan the capital structure of a firm.

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