Financial Leverage

Financial Leverage:

A company can raise its fund from a variety of sources, such as debt, preference share capital and equity capital. The rate of interest on debt is fixed irrespective of the company's Rate of Return (RoR). The company has a legal binding to pay interest on debt. The rate of preference dividend is also fixed but the preference dividends are paid when the company earns profit. The equity shareholders are entitled to the residual income. The rate of equity dividend is not fixed and depend on the dividend policy of the company.

The use of fixed charges source of fund such as debt and preference capital along with the owner's equity in the capital structure is described as financial leverage or trading on equity.

"Financial Leverage exists whenever a firm has debts or other sources of fund that carries fixed charges"

"Ability of a firm to use fixed financial charges to magnify the effects of changes in Earnings before interest and taxes(EBIT) on the firm's earning per share is financial leverage".

The financial leverage can be high or low. If the proportion of fixed cost capital is high, it will have a high financial leverage and if the proportion of variable cost is high, there will be low financial leverage. If a company is having low proportion of variable capital, this solution is also known as trading on equity.

The financial leverage may be favourable or unfavorable. If the cost of borrowed fund is less than the overall return of fund, it will be favourable financial leverage and otherwise, it will be unfavorable financial leverage.

Computation of financial leverage/ measurement of degree of leverage:

Financial Leverage = [EBIT ÷ (EBIT - I)]
                                    =(EBIT ÷ EBT)
                                    =(OP ÷ PBT)

Here,

EBIT= Earnings before interest and taxes

EBT = Earnings before taxes
I       = Interest
OP   = Operating Profit
PBT = Profit Before Taxes

Following 3 situations of capital structure may be there for computation of financial leverage:

1. When there is equity share capital and debt capital.

2. When there is equity share capital and preference share capital.

3. When there is equity share capital, preference share capital and debt capital.

Financing Decisions in International Business

Financing Decision:

The financing objective asserts that the mix of debt and equity selected to finance investment should maximize the value of investment made. Financing Decision consists of raising finance, different financial instruments and obligations attached to it. The finance manager involve in the following financing decisions:

1. Determining the level of gearing.

2. Determining the financing pattern of long-term fund requirements.

3. Determining the financing pattern of medium and short-term fund requirements.

4. Raising of fund through financial instruments like equity shares, preference shares, debentures, bonds, etc.

5. Arrangement of fund from banks and financial institutions for long term, medium term and short-term needs.

6. Arrangement of finance for working capital requirements.

7. Consideration of interest burden of the firm.

8. Taking advantage of interest and depreciation in reducing the tax liability of the firm.

For financing decision, the capital structure is broadly divided into:

a) Equity:

     The raising of fund through issue of shares is known as equity. The shareholders expect the return in the form of dividend. The dividend payments are made only if the distributable profits are available with the company after payment of interest charges and tax payment.

b) Debt:

     The debt funds are raised in the forms of debentures, bonds, term loans etc. The expectation of the provider of debt is to obtain return in the form of interest payments. The interest/debt is repaid as per the agreement. The interest should be paid irrespective of profitability of the firm.

How can we differentiate International Human Resource Management from Domestic Human Resource Management?

Managing human resource is considered to be the toughest task in managing the enterprise even in domestic business. The success and failure of an organisation depends to a large extent on how the dynamic human resources are selected, trained and motivated to bring out the best result.

Fundamentally, Domestic Human Resource Management and International Human Resource Management have the same processes and objectives. International Human Resource Management differs from Domestic Human Resource Management in terms of its scopes and it's objectives. Some of the factors that differentiate International Human Resource Management from Domestic Human Resource Management are:

1. The scope of human resource activities are larger because the organisation deals with multiple countries and employs from several culture.

2. International workforce requires greater involvement of management at a personal level.

3. The approach is complex because of the potential cultural mix in the workforce.

4. Expatriates are subject to tax at home and the host country. Hence, tax policy has to be decided in a way that they don't penalise the employee for moving to another country.

5. Relocation of staff involves providing immigration and travel services, providing housing, medical and training, international allowance and so on.

6. The laws in the host country vary from those of the parent country. The human resource department must be equipped to deal with all potential issues and ensure that the newly relocated employees and their families are able to function properly in the foreign country.

7. Differences in government policies of foreign countries require the human resource team to ensure that all the expatriates employees adhere to the norms set by the government.

Areas of concern for an international firm are adopting of staffing policies which specify the nationality of the managers for key possession at corporate office and foreign subsidiary, treatment of expatriate managers and maintaining cordial labour relations.

An international firm has wide choices as it can choose prospective candidates from home country, host country or even a third country. Apart from placing premium on the competency of the person, the stuffing policy should fit into the corporate culture of the firm and confirm to the local regulations of the foreign centres.