The Impact of Financial Leverage on Firms Performance

Abstract

This study examines the correlation between leverage and sales performance. Leverage is considered a crucial element in the realm of corporate finance, where a company's growth performance is evaluated by employing the logarithmic representation of its sales revenue. In order to ascertain the validity of our research findings, we took into account the fact that Pakistan possesses a significant number of enterprises, amounting to a total of 18,017. A comprehensive regression model was employed to ensure the model's impartiality and reliability, while also including all significant outcomes. The outcomes of this study are deemed noteworthy and reliable due to several compelling factors. There exists a notable negative correlation between leverage and sales performance, necessitating active engagement at every level of influence. This hyperlink is especially vital in relation to sales effectiveness. The decrease in sales income by 4% can be attributed to a simultaneous increase in the debt ratio by 10%. The debt ratio is calculated by dividing total commitments by total assets. Contrary to the commonly accepted notion that leverage has a substantial and contradictory influence on an organization's achievement, it is glaringly evident that loans are being utilised in a reckless manner. A successful leverage policy indicates that the business's performance has enhanced, rather than deteriorated. Considering this, the discoveries given in this study provoke significant inquiries. Based on the results, it is crucial for owners and managers to prioritise the efficient utilisation of leverage. This is due to the fact that improper utilisation of leverage greatly amplifies the likelihood of operational breakdown. Assuming all other factors stay unchanged, a higher debt-to-equity ratio suggests that banks are adopting a cautious strategy due to their apprehension about their ability to fulfil financial commitments. Moreover, restricting the accessibility of cash from external sources results in a decrease in competitiveness. The adverse consequences of an ill-advised leverage policy not only impede the growth potentials of other organisations, but also hinder their growth strategy. Financial market participants may interpret these findings as an additional cautionary signal. Providing external financing to firms lacking a clear capacity for expansion may heighten the risk of default. Ultimately, governments may come to see that they may provide substantial economic stimulus to firms that employ leverage in a responsible manner. Furthermore, we examined the influence of leverage on the returns of assets. The second metric employed in this investigation was the return on assets. Considering that the regression results indicate a negligible influence of leverage on return on assets (ROA), this poses a challenge that necessitates additional examination. We advocate performing extra study to get a more in-depth understanding of the elements that contribute to the negative association between leverage and sales performance. Furthermore, for freshly founded organisations, we propose undertaking a detailed investigation of the variables as well as reevaluating the correlation. As an extra advice, we advocate using solutions that consider the entity's size and origin. Finally, we feel that the sample size and technique utilised in this study will serve as a stimulus for future research, particularly in the assessment of the impact that corporate finance principles have on organisational performance in a variety of national and environmental situations.

Keywords-Financial Leverage and Firms Performance