Does financial leverage always improves the total return on capital employed?
Answers
Answer:
Improving ROCE
Because it is a measurement of profitability, a company can improve its ROCE through the same processes that it undertakes to improve its overall profitability. The most obvious place to start is by reducing costs or increasing sales. Monitoring areas that may be racking up excessive or inefficient costs is an important part of operational efficiency.
Another action that can improve the ROCE ratio is selling off unprofitable or unnecessary assets. For example, a company would do well to sell a piece of machinery that has outlived its useful life. Selling the outdated machinery would lower the company’s total asset base and thus improve the company’s ROCE since removing unused or unnecessary assets allows for less capital to be employed to facilitate the same amount of production.
Paying off debt, thereby reducing liabilities, can also improve the ROCE ratio. Another step a company can take in the area of financing is to restructure existing debt, refinancing at lower interest rates or with more attractive repayment terms.
A key area to overall operational inefficiency that may be improved upon is inventory management. Proper inventory management can often be a very effective means of improving a company's overall financial performance. Proper monitoring, organization, and coordination of ordering inventory can significantly improve a company's cash flow and available working capital. This allows the company to reinvest more capital back into the company on a regular basis, which enables it to grow and increase its market base
Does financial leverage always improves the total return on capital employed?
No, Financial leverage does not always improve the total return on capital employed. Financial leverage is used to increase the return on equity, but when the amount of financial leverage becomes high, there is also an increased chance of failure, as more debt becomes more difficult to pay off.
Financial leverage is measured as the ratio of total debt to total assets. As their ratio of assets to assets increases, so does the amount of financial leverage. Financial leverage is useful when the interest associated with using them generates more than the expense.
Many companies also use financial leverage instead of acquiring equity, which can reduce the earnings per share of existing shareholders.
The use of financial leverage is most meaningful when it is expected to generate significant cash flow. In such a situation, it becomes easy to estimate the amount of cash available to pay off the loan.
Hence we can say that financial leverage does not always improve the total return on capital.
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