The financial leverage in which debt is related to net equity as shown in the following formula:
This tool is used to examine the solvency of a firm. The appropriate net financial leverage depends on many factors including the context in which the firm operates (i.e., its industry structure) and the volatility of input prices and volatility in demand for the products or services being delivered by the firm. For instance, with respect to industry structure , net financial leverage is determined in light of the proportion of fixed costs in the total cost incurred on delivering products or services to clients. If the proportion of fixed costs is high, the firm would opt for low leverage. Otherwise, the firm has the flexibility to rely on high leverage.
