## Introduction to Leverages
The word leverage means influence or power. In financial analysis it represents the influence of one financial variable over another related variable — a magnifying effect. These variables include costs, output, sales revenue, EBIT and EPS.
### Link to the objective of financial management
- The objective of financial management is to maximise wealth, where wealth = market value.
- Value is directly related to the company's performance and inversely related to investors' expectations.
- Investors' expectations depend on the risk of the company.
- Therefore, to maximise value, a company must manage its risk.
### Two types of risk
| Risk | Meaning | Source |
|---|---|---|
| Business Risk | Risk associated with the firm's operations — uncertainty about future operating income (EBIT); i.e., how well can operating income be predicted? | Nature of operations / fixed operating costs |
| Financial Risk | Additional risk placed on shareholders because of the use of debt — the extra risk a shareholder bears when the firm uses debt alongside equity | Use of debt (fixed financial cost) |
A firm that issues more debt carries higher financial risk than a firm financed mostly or entirely by equity.
This chapter examines the factors that influence business and financial risk through the study of leverages.