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Financial leverage is the degree to which an organization is utilizing debt (borrowed money) for operations. The financial leverage ratios measure organizations assets relative to available equity; higher leverage positions are generally riskier than lower leveraged positions. Firms need to ensure that their return on assets (ROA) and cash flow are sufficient to service their debt or else they could become insolvent. To ensure that this does not occur, it is advised that the operating to financial leverage ratio does not exceed 2:1. Anything above a 2:1 ratio indicates a highly leverage position which is risky and not sustainable in the long term.
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