The effect of financial leverage this is an indicator that reflects the change in the return on equity obtained through the use of borrowed funds and is calculated using the following formula:

Where,
DFL - effect of financial leverage, in percent;
t - income tax rate, in relative terms;
ROA - return on assets (economic return on EBIT) in%;

D - borrowed capital;
E - equity.

The effect of financial leverage is manifested in the difference between the cost of borrowed and allocated capital, which allows you to increase the return on equity and reduce financial risks.

The positive effect of financial leverage is based on the fact that the bank rate in a normal economic environment is lower than the return on investment. The negative effect (or the reverse side of financial leverage) occurs when the return on assets falls below the loan rate, which leads to accelerated loss formation.

Incidentally, the common theory is that the US mortgage crisis was a manifestation of the negative effect of financial leverage. When the program of non-standard mortgage lending was launched, interest rates on loans were low, while real estate prices were growing. The low-income strata of the population were involved in financial speculation, since almost the only way for them to repay the loan was the sale of housing that had risen in price. When housing prices crept down, and loan rates rose due to increasing risks (the leverage began to generate losses, not profits), the pyramid collapsed.

Components effect of financial leverage are shown in the figure below:

As can be seen from the figure, the effect of financial leverage (DFL) is the product of two components, adjusted by the tax coefficient (1 - t), which shows the extent to which the effect of financial leverage is manifested due to different levels of income tax.

One of the main components of the formula is the so-called financial leverage differential (Dif) or the difference between the return on the company's assets (economic profitability), calculated on EBIT, and the interest rate on borrowed capital:

Dif = ROA - r

Where,
r - interest rate on borrowed capital, in %;
ROA - return on assets (economic return on EBIT) in%.

The financial leverage differential is the main condition that forms the growth of return on equity. For this, it is necessary that the economic profitability exceed the interest rate of payments for the use of borrowed sources of financing, i.e. the financial leverage differential must be positive. If the differential becomes less than zero, then the effect of financial leverage will only act to the detriment of the organization.

The second component of the effect of financial leverage is the coefficient of financial leverage (shoulder of financial leverage - FLS), which characterizes the strength of the impact of financial leverage and is defined as the ratio of borrowed capital (D) to equity (E):

Thus, the effect of financial leverage consists of the influence of two components: differential and lever arm.

The differential and lever arm are closely interconnected. As long as the return on investment in assets exceeds the price of borrowed funds, i.e. the differential is positive, the return on equity will grow the faster, the higher the ratio of borrowed and own funds. However, as the share of borrowed funds grows, their price rises, profits begin to decline, as a result, the return on assets also falls and, therefore, there is a threat of obtaining a negative differential.

According to economists, based on the study of empirical material from successful foreign companies, the optimal effect of financial leverage is within 30-50% of the level of economic return on assets (ROA) with a financial leverage of 0.67-0.54. In this case, an increase in the return on equity is ensured not lower than the increase in the profitability of investments in assets.

The effect of financial leverage contributes to the formation of a rational structure of the sources of funds of the enterprise in order to finance the necessary investments and obtain the desired level of return on equity, in which the financial stability of the enterprise is not violated.

Using the above formula, we will calculate the effect of financial leverage.

Indicators Ed. rev. Value
Equity thousand roubles. 45 879,5
Borrowed capital thousand roubles. 35 087,9
Total capital thousand roubles. 80 967,4
Operating profit thousand roubles. 23 478,1
Interest rate on borrowed capital % 12,5
The amount of interest on borrowed capital thousand roubles. 4 386,0
Income tax rate % 24,0
Taxable income thousand roubles. 19 092,1
Income tax amount thousand roubles. 4 582,1
Net profit thousand roubles. 14 510,0
Return on equity % 31,6%
Effect of financial leverage (DFL) % 9,6%

The calculation results presented in the table show that by attracting borrowed capital, the organization was able to increase the return on equity by 9.6%.

Financial leverage characterizes the possibility of increasing the return on equity and the risk of loss financial stability. The higher the share of borrowed capital, the higher the sensitivity of net income to changes in balance sheet profit. Thus, with additional borrowing, the return on equity may increase, provided:

if ROA > i, then ROE > ROA and ΔROE = (ROA - i) * D/E

Therefore, it is advisable to attract borrowed funds if the achieved return on assets, ROA exceeds the interest rate for the loan, i. Then an increase in the share of borrowed funds will increase the return on equity. However, at the same time, it is necessary to monitor the differential (ROA - i), since with an increase in the leverage of financial leverage (D / E), lenders tend to compensate for their risk by increasing the rate for the loan. The differential reflects the lender's risk: the larger it is, the lower the risk. The differential should not be negative, and the effect of financial leverage should optimally be equal to 30 - 50% of the return on assets, since the stronger the effect of financial leverage, the higher the financial risk of loan default, falling dividends and share prices.

The level of associated risk characterizes the operational and financial leverage. Operating and financial leverage, along with the positive effect of increasing the return on assets and equity as a result of growth in sales and borrowings, also reflects the risk of lower profitability and incurring losses.

Financial lever characterizes the ratio of all assets to equity, and the effect of financial leverage is calculated by multiplying it by the economic profitability indicator, that is, it characterizes the return on equity (the ratio of profit to equity).

The effect of financial leverage is an increment to the return on equity obtained through the use of a loan, despite the payment of the latter.

An enterprise using only its own funds limits their profitability to about two-thirds of economic profitability.

РСС - net profitability of own funds;

ER - economic profitability.

An enterprise using a loan increases or decreases the return on equity, depending on the ratio of own and borrowed funds in liabilities and on the interest rate. Then there is the effect of financial leverage (EFF):

(3)

Consider the mechanism of financial leverage. In the mechanism, a differential and a shoulder of financial leverage are distinguished.

Differential - the difference between the economic return on assets and the average calculated interest rate (AMIR) on borrowed funds.

Due to taxation, unfortunately, only two-thirds of the differential remain (1/3 is the profit tax rate).

Shoulder of financial leverage - characterizes the strength of the impact of financial leverage.

(4)

Let's combine both components of the effect of financial leverage and get:

(5)

(6)

Thus, the first way to calculate the level of financial leverage effect is:

(7)

The loan should lead to an increase in financial leverage. In the absence of such an increase, it is better not to take a loan at all, or at least calculate the maximum maximum amount of credit that leads to growth.

If the loan rate is higher than the level of economic profitability of the tourist enterprise, then increasing the volume of production due to this loan will not lead to the return of the loan, but to the transformation of the enterprise from profitable to unprofitable.



Here we should highlight two important rules:

1. If a new borrowing brings the company an increase in the level of financial leverage, then such borrowing is profitable. But at the same time, it is necessary to monitor the state of the differential: when increasing the leverage of financial leverage, a banker is inclined to compensate for the increase in his risk by increasing the price of his “commodity” - a loan.

2. The creditor's risk is expressed by the value of the differential: the larger the differential, the lower the risk; the smaller the differential, the greater the risk.

You should not increase the financial leverage at any cost, you need to adjust it depending on the differential. The differential must not be negative. And the effect of financial leverage in world practice should be equal to 0.3 - 0.5 of the level of economic return on assets.

Financial leverage allows you to assess the impact of the capital structure of the enterprise on profit. Calculation this indicator it is expedient from the point of view of assessing the effectiveness of the past and planning the future financial activities of the enterprise.

Advantage rational use financial leverage is the ability to generate income from the use of capital borrowed at a fixed percentage in investment activity that pays a higher interest than what is paid. In practice, the value of financial leverage is affected by the scope of the enterprise, legal and credit restrictions, and so on. Too high financial leverage is dangerous for shareholders, as it involves a significant amount of risk.

Commercial risk means uncertainty about possible outcome, the uncertainty of this result of activity. Recall that risks are divided into two types: pure and speculative.

Financial risks are speculative risks. An investor, making a venture capital investment, knows in advance that only two types of results are possible for him: income or loss. A feature of financial risk is the likelihood of damage as a result of any operations in the financial, credit and exchange areas, transactions with stock securities, that is, the risk that follows from the nature of these operations. Financial risks include credit risk, interest rate risk, currency risk, risk of lost financial profit.

The concept of financial risk is closely related to the category of financial leverage. Financial risk is the risk associated with possible disadvantage funds to pay interest on long-term loans and borrowings. The increase in financial leverage is accompanied by an increase in the degree of riskiness of this enterprise. This is manifested in the fact that for two tourist enterprises with the same volume of production, but different level financial leverage, the variation in net profit due to changes in the volume of production will not be the same - it will be greater for an enterprise with a higher level of financial leverage.

The effect of financial leverage can also be interpreted as the change in net income per ordinary share (as a percentage) generated by a given change in the net result of the operation of investments (also as a percentage). This perception of the effect of financial leverage is typical mainly for American school financial management.

Using this formula, they answer the question of how many percent the net profit per ordinary share will change if the net result of the operation of investments (profitability) changes by one percent.

After a series of transformations, you can go to the formula of the following form:

Hence the conclusion: the higher the interest and the lower the profit, the greater the strength of the financial leverage and the higher the financial risk.

When forming a rational structure of sources of funds, it is necessary to proceed from following fact: to find such a ratio between borrowed and own funds at which the value of the company's shares will be the highest. This, in turn, becomes possible with a sufficiently high, but not excessive effect of financial leverage. The level of debt is for the investor a market indicator of the well-being of the enterprise. Extremely high specific gravity borrowed funds in liabilities indicates an increased risk of bankruptcy. If the tourist enterprise prefers to manage with its own funds, then the risk of bankruptcy is limited, but investors, receiving relatively modest dividends, believe that the enterprise does not pursue the goal of maximizing profits, and begin to dump shares, reducing the market value of the enterprise.

There are two important rules:

1. If the net result of the operation of investments per share is small (and at the same time the financial leverage differential is usually negative, the net return on equity and the dividend level are lower), then it is more profitable to increase equity by issuing shares than to take out a loan: attracting borrowed funds funds costs the company more than raising its own funds. However, there may be difficulties in the process of initial public offering.

2. If the net result of exploitation of investments per share is large (and at the same time the financial leverage differential is most often positive, the net return on equity and the dividend level are increased), then it is more profitable to take a loan than to increase own funds: raising borrowed funds costs the enterprise cheaper than raising own funds. Very important: it is necessary to control the strength of the impact of financial and operational leverage in the event of their possible simultaneous increase.

Therefore, you should start by calculating the net return on equity and net earnings per share.

(10)

1. The pace of increasing the turnover of the enterprise. Increased turnover growth rates also require increased funding. This is due to the increase in variable, and often fixed costs, the almost inevitable swelling of receivables, as well as many other very different reasons, including cost inflation. Therefore, on a steep rise in turnover, firms tend to rely not on internal, but on external financing, with an emphasis on increasing the share of borrowed funds in it, since share issue costs, initial public offering costs and subsequent dividend payments most often exceed the value of debt instruments;

2. Stability of turnover dynamics. An enterprise with a stable turnover can afford a relatively larger share of borrowed funds in liabilities and higher fixed costs;

3. Level and dynamics of profitability. It is noted that the most profitable enterprises have a relatively low share of debt financing on average over a long period. The enterprise generates sufficient profits to finance development and pay dividends, and is increasingly self-sufficient;

4. Structure of assets. If an enterprise has significant general-purpose assets that, by their very nature, can serve as collateral for loans, then increasing the share of borrowed funds in the liability structure is quite logical;

5. The severity of taxation. The higher the income tax, the less tax incentives and opportunities to use accelerated depreciation, the more attractive debt financing for the enterprise due to attributing at least part of the interest for the loan to the cost;

6. Attitude of creditors to the enterprise. The game of supply and demand on money and financial markets determines the average terms of credit financing. But the specific conditions for granting this loan may deviate from the average, depending on the financial and economic situation of the enterprise. Whether bankers compete for the right to provide a loan to an enterprise, or money has to be begged from creditors - that is the question. The real possibilities of the enterprise to form the desired structure of funds largely depend on the answer to it;

8. Acceptable degree of risk for the leaders of the enterprise. The people at the helm may be more or less conservative in terms of risk tolerance when making financial decisions;

9. Strategic target financial settings of the enterprise in the context of its actually achieved financial and economic position;

10. The state of the market for short- and long-term capital. With an unfavorable situation in the money and capital market, it is often necessary to simply obey the circumstances, postponing until better times the formation of a rational structure of sources of funds;

11. Financial flexibility of the enterprise.

Example.

Determining the amount of financial leverage economic activity enterprises on the example of the hotel "Rus". Let us determine the expediency of the size of the attracted credit. The structure of enterprise funds is presented in Table 1.

Table 1

Structure financial resources enterprises of the hotel "Rus"

Index Value
Initial values
Hotel asset minus credit debt, mln. rub. 100,00
Borrowed funds, million rubles 40,00
Own funds, million rubles 60,00
Net result of investment exploitation, mln. rub. 9,80
Debt servicing costs, million rubles 3,50
Estimated values
Economic profitability of own funds, % 9,80
Average calculated interest rate, % 8,75
Financial leverage differential excluding income tax, % 1,05
Financial leverage differential including income tax, % 0,7
Financial Leverage 0,67
Effect of financial leverage, % 0,47

Based on these data, the following conclusion can be drawn: the Rus Hotel can take out loans, but the differential is close to zero. Minor changes in the production process or higher interest rates can reverse the effect of leverage. There may come a time when the differential becomes less than zero. Then the effect of financial leverage will act to the detriment of the hotel.

The leverage of financial leverage is used both at the enterprise, to calculate the required amount of a loan secured by assets, and in exchange trading. This tool helps to increase profits by attracting external sources funds. However, its inept use can lead to a deterioration in the economic condition and even cause bankruptcy.

What is financial leverage

The leverage of financial leverage is the ratio of own assets in relation to borrowed funds. In fact, it expresses the ability of the enterprise to pay the debt on time and in full. Banks and other lending institutions are required to calculate this parameter in order to determine the maximum loan amount they can give to an enterprise. This definition is valid for both enterprises and individual investors using this instrument during speculative transactions. It is usually expressed as a share or percentage of the funds received in debt or temporary use. For enterprises and banks, some formulas for calculating financial leverage are used, for investors - others. When using this tool, it is important to evaluate not only the benefits of the application, but also the risk that it carries.

purpose

Financial leverage is needed in order to increase the amount working capital. Entrepreneurs resort to this financial instrument in order to expand economic activity. You can also solve other financial problems related to the activities of the enterprise with the help of a loan.

The calculation of the leverage of financial leverage is carried out by both banks and individual businessmen. It is necessary in order to correctly evaluate possible risks associated with the use of leverage, as well as to determine the amount that an enterprise or investor can count on.

Calculation formula

To calculate the leverage of financial leverage, the formula is as follows:

DFL \u003d ((1-T) * (ROA - p) * D) / E,

where DFL denotes the effect of financial leverage;

T is the percentage rate of the income tax adopted in the country;

ROA - profitability of the company's assets;

p is the interest rate on the loan;

D - the amount of funds taken on credit;

E - equity.

However, among managers and accountants, another formula for calculating the leverage of financial leverage has become widespread. The data for the calculations are taken from the financial statements. It looks like this:

DFL \u003d ROE - ROA,

where ROE is the return on equity. This parameter is calculated by the formula:

POE \u003d Net profit / Total for section 3.

Return on assets of the enterprise is calculated by the formula:

ROA = Net profit / Total balance sheet.

This method is convenient because all calculations can be automated. In addition, this way you can only evaluate the effect of using the leverage of financial leverage, and not calculate the amount necessary to expand or maintain the stable operation of the enterprise. This formula is not used to analyze past and current activities, but to predict.

Calculation example

In order to make the above formulas clearer, below are the calculations made for the JSC "Snezhka" enterprise based on the data of its annual report.

POE \u003d - 21055 / 480171 \u003d - 0.044;

ROA \u003d -21055 / 1488480 \u003d - 0.014;

DFL = - 0.044 + 0.014 = - 0.03;

How to interpret the received information? What does the result mean? If, when calculating the ratio of borrowed and own funds, it turned out to be less than 0.8, then the state of the enterprise is considered not quite stable. The company does not have enough current assets that it can sell to repay short-term loans. If it is more than 0.8 or equal to it, then the risk is insignificant and nothing threatens the enterprise, since it will be able to sell its assets in a timely manner and make a payment if necessary.

As can be seen from the calculations, JSC "Snezhka" is not only unable to pay off current debts, but it is also not entitled to receive a new bank loan to expand its activities. Here at least to pay off the debts that have arisen. This situation has been observed in many Russian enterprises, especially over the past 2-3 years. However, this is not a reason for the bank to take risks once again. To determine whether the financial leverage will help to rectify the situation, the calculations must be carried out not for one year, but for 3-5 years of the enterprise's operation.

What do the data obtained during the calculations mean?

The ratio of borrowed and own funds was obtained. But calculations are only half the battle. The information received needs to be analyzed. The degree of risk depends on how correct the analysis and the decision will be. For a bank - the return of loans issued, for a businessman - the stable operation of the enterprise and the likelihood of bankruptcy.

As can be seen from the above example, the company has serious problems. In the current period, it received a net loss. The organization can take a loan from a bank to cover the debt that has arisen in connection with the received loss. But this threatens with a loss of stability and the risk of late payments on loans, which, in turn, will lead to unforeseen expenses in the form of interest and fines.

If an entrepreneur knows in advance the amount of the loan that he can count on, he can better plan where and on what he can spend these funds. This is the benefit of such calculations.

The use of financial leverage on the stock and currency exchange

The leverage of financial leverage has become most widely used in trading operations on the stock and currency exchanges. By raising borrowed funds, an investor can acquire more, which means a higher profit. But the use of leverage in such risky operations often leads to big losses in a short time.

When calculating the leverage for investors conducting speculative operations on the stock exchange, the formula is not used. In this case, the leverage of financial leverage is the ratio between the amount of capital and the loan provided for temporary use. The ratio can be as follows: 1:10, 1:50, etc. The larger the ratio, the higher the risk. The amount of the deposit is multiplied by the size of the leverage. Since fluctuations in the exchange are usually only a few percent, leverage allows you to increase the volume of used Money tens and hundreds of times, which makes the profit (loss) significant.

Financial leverage is considered to be the potential opportunity to manage the profit of the organization by changing the amount and components of capital

own and borrowed.
Financial leverage (leverage) is used by entrepreneurs when the goal arises to increase the income of the enterprise. After all, it is financial leverage that is considered one of the main mechanisms for managing the profitability of an enterprise.
In the case of using such a financial instrument, the company attracts borrowed money by making credit transactions, this capital replaces its own capital and all financial activities are carried out only with the use of credit money.
But it should be remembered that in this way the enterprise significantly increases its own risks, because regardless of whether the invested funds brought profit or not, it is necessary to pay on debt obligations.
When using financial leverage, one cannot ignore the effect of financial leverage. This indicator is a reflection of the level of additional profit on the equity capital of the enterprise, taking into account the different share of the use of credit funds. Often, when calculating it, the formula is used:

EFL \u003d (1 - Cnp) x (KBRa - PC) x ZK / SK,
where

  • EFL- effect of financial leverage, %;
  • Cnp- income tax rate, which is expressed as a decimal fraction;
  • KBPa- coefficient of gross profitability of assets (characterized by the ratio of gross profit to the average value of assets),%;
  • PC - the average size interest on the loan, which the company pays for the use of attracted capital,%;
  • ZK- the average amount of attracted capital used;
  • SC- the average amount of own capital of the enterprise.

Components of financial leverage

This formula has three main components:
1. Tax corrector (1-Cnp)- a value indicating how the EFL will change when the level of taxation changes. The enterprise has practically no effect on this value, tax rates are set by the state. But financial managers can use the change in the tax corrector to obtain the desired effect if some branches (subsidiaries) of the enterprise are subject to different tax policies due to the territorial location, types of activities.
2.Financial leverage differential (KBRa-PC). Its value fully reveals the difference between the gross return on assets and the average interest rate on a loan. The higher the value of the differential, the greater the likelihood of a positive effect from the financial impact on the enterprise. This indicator is very dynamic, constant monitoring of the differential will allow you to control the financial situation and not miss the moment of reducing the profitability of assets.
3. Financial leverage ratio (LC/LC), which characterizes the amount of credit capital attracted by the enterprise, per unit of equity. It is this value that causes the effect of financial leverage: positive or negative, which is obtained due to the differential. That is, a positive or negative increase in this coefficient causes an increase in the effect.
The combination of all components of the effect of financial leverage will allow you to determine exactly the amount of borrowed funds that will be safe for the enterprise and will allow you to get the desired increase in profits.

Financial leverage ratio

The leverage ratio shows the percentage of borrowed funds in relation to the company's own funds.
Net borrowings are bank loans and overdrafts minus cash and other liquid resources.
Equity is represented by the balance sheet value of shareholders' funds invested in the company. This is the issued and paid-in authorized capital, accounted for at the nominal value of shares, plus accumulated reserves. The reserves are the retained earnings of the company since incorporation, as well as any increment resulting from the revaluation of property and additional capital, where available.
It happens that even listed companies have a leverage ratio of more than 100%. This means that creditors provide more financial resources for the operation of the company than shareholders. In fact, there have been exceptional cases where listed companies had a leverage ratio of around 250% - temporarily! This may have been the result of a major takeover that required significant borrowing to pay for the acquisition.

In such circumstances, however, it is highly likely that the Chairman's report presented in the annual report contains information on what has already been done and what remains to be done in order to significantly reduce the level of financial leverage. In fact, it may even be necessary to sell some lines of business in order to reduce leverage to an acceptable level in a timely manner.
The consequence of high financial leverage is a heavy burden of interest on loans and overdrafts, which are charged to the profit and loss account. In the face of deteriorating economic conditions, profits may well be under a double yoke. There may be not only a reduction in trading revenue, but also an increase in interest rates.
One way to determine the impact of financial leverage on profits is to calculate the interest coverage ratio.
The rule of thumb is that the interest coverage ratio should be at least 4.0, and preferably 5.0 or more. This rule should not be neglected, because the loss of financial well-being can become a retribution.

Leverage ratio (Debt ratio)

Leverage ratio (debt ratio, debt-to-equity ratio)- index financial position enterprise, characterizing the ratio of borrowed capital and all assets of the organization.
The term "financial leverage" is also used to characterize a principled approach to business financing, when, with the help of borrowed funds, an enterprise forms a financial leverage to increase the return on its own funds invested in a business.
Leverage(Leverage - “lever” or “lever action”) is a long-term operating factor, the change of which can lead to a significant change in a number of performance indicators. This term used in financial management to characterize a relationship showing how an increase or decrease in the share of any group of semi-fixed costs affects the dynamics of the income of the company's owners.
The following term names are also used: autonomy coefficient, financial dependence coefficient, financial leverage coefficient, debt load.
The essence of the debt burden is as follows. Using borrowed funds, the company increases or decreases the return on equity. In turn, the decrease or increase in ROE depends on the average cost of borrowed capital (average interest rate) and makes it possible to judge the effectiveness of the company in choosing sources of financing.

Method for calculating the coefficient of financial dependence

This indicator describes the company's capital structure and characterizes its dependence on . It is assumed that the amount of all debts should not exceed the amount of equity capital.
The calculation formula for the financial dependency ratio is as follows:
Liabilities / Assets
Liabilities are considered both long-term and short-term (whatever is left after subtracting from the equity balance). Both components of the formula are taken from balance sheet organizations. However, it is recommended to make calculations based on the market valuation of assets, and not financial statements. Since a successfully operating enterprise, the market value of equity capital may exceed book value, which means a smaller value of the indicator and more low level financial risk.
As a result, the normal value of the coefficient should be 0.5-0.7.

  • Coefficient 0.5 is optimal (equal ratio of own and borrowed capital).
  • 0.6-0.7 - is considered a normal coefficient of financial dependence.
  • A ratio below 0.5 indicates an organization's too cautious approach to raising debt capital and missed opportunities to increase the return on equity by using the effect of financial leverage.
  • If the level of this indicator exceeds the recommended number, then the company has a high dependence on creditors, which indicates a deterioration in financial stability. The higher the ratio, the greater the company's risks regarding the potential for bankruptcy or a shortage of cash.

Conclusions from the value of the Debt ratio
The financial leverage ratio is used to:
1) Comparisons with the average level in the industry, as well as with indicators from other firms. The value of the financial leverage ratio is influenced by the industry, the scale of the enterprise, as well as the method of organizing production (capital-intensive or labor-intensive production). Therefore, the final results should be evaluated in dynamics and compared with the indicator of similar enterprises.
2) Analysis of the possibility of using additional borrowed sources of financing, the efficiency of production and marketing activities, the optimal decisions of financial managers in matters of choosing objects and sources of investment.
3) Analysis of the debt structure, namely: the share of short-term debts in it, as well as tax debts, wages, various deductions.
4) Determination by creditors of financial independence, stability of the financial position of an organization that plans to attract additional loans.

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Ural Socio-Economic Institute

Academy of Labor and Social Relations

Department of Financial Management

Course work

Course: Financial Management

Topic: The effect of financial leverage: financial and economic content, calculation methods and scope in making managerial decisions.

Form of study: Correspondence

Specialty: Finance and Credit

Course: 3, Group: FSZ-302B

Completed by: Mingaleev Dmitry Rafailovich

Chelyabinsk 2009


Introduction

1. The essence of the effect of financial leverage and calculation methods

1.1 The first way to calculate financial leverage

1.2 The second method of calculating financial leverage

1.3 The third method of calculating financial leverage

2. Coupled effect of operational and financial leverage

3. Strength of financial leverage in Russia

3.1 Controllable factors

3.2 Business size matters

3.3 Structure external factors affecting the effect of financial leverage

Conclusion

Bibliography

Introduction

Profit is the simplest and at the same time the most complex economic category. She received a new content in the conditions of modern economic development countries, the formation of real independence of business entities. Being the main driving force market economy, it ensures the interests of the state, owners and personnel of the enterprise. Therefore, one of the urgent tasks modern stage is the mastery of managers and financial managers with modern methods of effective management of profit formation in the process of production, investment and financial activities of the enterprise. The creation and operation of any enterprise is simply a process of investing financial resources on a long-term basis in order to make a profit. Of priority importance is the rule that both own and borrowed funds must provide a return in the form of profit. Competent, effective management formation of profit involves the construction at the enterprise of appropriate organizational and methodological systems for ensuring this management, knowledge of the main mechanisms for generating profit, the use modern methods its analysis and planning. One of the main mechanisms for the implementation of this task is the financial lever

The purpose of this work is to study the essence of the effect of financial leverage.

Tasks include:

Consider the financial and economic content

Consider calculation methods

Consider the scope


1. The essence of the effect of financial leverage and calculation methods

Profit formation management involves the use of appropriate organizational and methodological systems, knowledge of the main mechanisms of profit formation and modern methods of its analysis and planning. When using a bank loan or issuing debt securities interest rates and the amount of debt remain constant during the term of the loan agreement or the term of circulation of securities. The costs associated with servicing the debt do not depend on the volume of production and sales of products, but directly affect the amount of profit remaining at the disposal of the enterprise. Since interest on bank loans and debt securities is charged to enterprises (operating expenses), using debt as a source of financing is cheaper for the enterprise than other sources that are paid out of net income (for example, dividends on shares). However, an increase in the share of borrowed funds in the capital structure increases the risk of insolvency of the enterprise. This should be taken into account when choosing funding sources. It is necessary to determine the rational combination between own and borrowed funds and the degree of its impact on the profit of the enterprise. One of the main mechanisms for achieving this goal is financial leverage.

Financial leverage (leverage) characterizes the use of borrowed funds by the enterprise, which affects the value of return on equity. Financial leverage is an objective factor that arises with the advent of borrowed funds in the amount of capital used by the enterprise, allowing it to receive additional profit on equity.

The idea of ​​financial leverage American concept consists in assessing the level of risk for fluctuations in net profit caused by the constant value of the company's debt service costs. Its action is manifested in the fact that any change in operating profit (earnings before interest and taxes) generates a more significant change in net profit. Quantitatively, this dependence is characterized by the indicator of the strength of the impact of financial leverage (SVFR):

Interpretation of the financial leverage ratio: it shows how many times earnings before interest and taxes exceed net income. lower bound coefficient is unity. The greater the relative amount of borrowed funds attracted by the enterprise, the greater the amount of interest paid on them, the higher the impact of financial leverage, the more variable the net profit. Thus, an increase in the share of borrowed financial resources in total amount long-term sources of funds, which, by definition, is tantamount to an increase in the impact of financial leverage, other things being equal, leads to greater financial instability, expressed in less predictable net profit. Since the payment of interest, unlike, for example, the payment of dividends, is mandatory, then with relatively high level financial leverage, even a slight decrease in profits may have adverse effects compared to a situation where the level of financial leverage is low.

The higher the force of financial leverage, the more non-linear the relationship between net income and earnings before interest and taxes becomes. A slight change (increase or decrease) in earnings before interest and taxes under conditions of high financial leverage can lead to a significant change in net income.

The increase in financial leverage is accompanied by an increase in the degree of financial risk of the enterprise associated with a possible lack of funds to pay interest on loans and borrowings. For two enterprises with the same volume of production, but different levels of financial leverage, the variation in net profit due to changes in the volume of production is not the same - it is greater for an enterprise with a higher value of the level of financial leverage.

European concept of financial leverage characterized by an indicator of the effect of financial leverage, reflecting the level of additionally generated profit on equity with a different share of the use of borrowed funds. This method of calculation is widely used in the countries of continental Europe (France, Germany, etc.).

The effect of financial leverage(EFF) shows by what percentage the return on equity increases by attracting borrowed funds into the turnover of the enterprise and is calculated by the formula:

EGF \u003d (1-Np) * (Ra-Tszk) * ZK / SK

where N p - the rate of income tax, in fractions of units;

Rp - return on assets (the ratio of the amount of profit before interest and taxes to the average annual amount of assets), in fractions of units;

C zk - weighted average price of borrowed capital, in fractions of units;

ZK - the average annual cost of borrowed capital; SC is the average annual cost of equity capital.

There are three components in the above formula for calculating the effect of financial leverage:

♦ financial leverage tax corrector(l-Np), which shows the extent to which the effect of financial leverage is manifested in connection with different levels of taxation of profits;

♦ leverage differential(ra -C, k), which characterizes the difference between the profitability of the enterprise's assets and the weighted average calculated interest rate on loans and borrowings;

♦ financial leverage ZK/SK

the amount of borrowed capital per ruble of the company's own capital. In terms of inflation, the formation of the effect of financial leverage is proposed to be considered depending on the rate of inflation. If the amount of the company's debt and interest on loans and borrowings are not indexed, the effect of financial leverage increases, since debt servicing and the debt itself are paid for with already depreciated money:

EGF \u003d ((1-Np) * (Ra - Tsk / 1 + i) * ZK / SK,

where i is the characteristic of inflation (inflationary rate of price growth), in fractions of units.

In the process of managing financial leverage, a tax corrector can be used in the following cases:

♦ if by various types activities of the enterprise differentiated tax rates are established;

♦ if by certain types activities, the enterprise uses income tax benefits;

♦ if individual subsidiaries of the enterprise operate in free economic zones in their own country, where there is a preferential income tax regime, as well as in foreign countries.

In these cases, by influencing the sectoral or regional structure of production and, accordingly, the composition of profit in terms of its taxation level, it is possible, by reducing the average profit tax rate, to reduce the impact of the financial leverage tax corrector on its effect (ceteris paribus).

The financial leverage differential is a condition for the emergence of the effect of financial leverage. A positive EGF occurs in cases where the return on total capital (Ra) exceeds the weighted average price of borrowed resources (Czk)