Question

Describe the level of financial leverage used by Microsoft (high, medium, or low).Is that level of leverage an advantage or disadvantage to the company? Explain your answer.

Answer 1

Financial leverage refers to the presence of debt capital in the capital structure of a company and is measured by ratios like Debt to Total Capital ratio. Higher the financial leverage, higher will be the company's susceptibility to default on debt payments owing to poor operating conditions, thus higher financial risk.

Microsoft has been relying more on equity financing than debt in the past years, its debt to capital ratio has decreased from 10.4% in June 2018 to 7.8% in June 2019. The company's reducing use of debt from the past 3 years is indicative of the fact that the Company wishes to keep its financial risk levels at a moderate to low level. In past 3 years, the free cash flows of Microsoft amounted to a robust 95% of EBIT which is a good enough performance to pay off its debt comfortably. Hence, the current level of debt employed by microsoft and the overall cautiuos strategy of the Company in terms of taking financial risk is advantageous to the Company.