Leverage, Volatility, and Financial Risk
Financial risk is, in good measure, related to the uncertainty of profit coverage of interest payments and principal repayments. This note examines the effects of cyclical changes in volume on financial safety and on stockholder income and illustrates the factors that have more profound effects on income/risk considerations in a financial decision. The note is divided into three parts. The first section considers the impacts of leverage (both operating and financial), sales volatility, and growth on profits after taxes (a step away from shareholder income). The next part traces the relationship of these variables to burden coverage. These terms will be defined as appropriate. A final section illustrates financial risk from the equity shareholder's point of view.