home In contact with Leverage of financial leverage (financial leverage): concept and methods of assessment. Financial leverage (leverage) Financial leverage is

Leverage of financial leverage (financial leverage): concept and methods of assessment. Financial leverage (leverage) Financial leverage is

Financial leverage- this is a factor in changing financial results, expressed in the structure of sources of financing and measured, in particular, as the ratio of debt and equity capital.

If the share of borrowed capital in the amount of long-term sources is large, they speak of a high value of financial leverage and high financial risk.

All other things being equal, the attraction of borrowed capital is accompanied by an increase in financial leverage and, accordingly, an increase in the financial risk personified by a given company.

Financial leverage is calculated in the FinEkAnalysis program in the block Calculation of the effect of financial leverage.

Financial leverage effect - formula

Effect of financial leverage,% = (1 - SNP) * (KVRa - PC) * 3K / SK

SNP – profit tax rate, expressed as a decimal fraction;
KVRa – gross return on assets ratio (ratio of gross profit to average asset value),%;
PC – average interest rate on a loan paid by an enterprise for the use of borrowed capital,%
ZK – average amount of borrowed capital;
SK – average amount of equity capital.

The financial leverage effect - what it shows

This is an indicator that reflects the level of additionally generated return on equity at different levels of use of borrowed funds in the capital structure.

There are limits to the growth of financial leverage. A decrease in the level of financial stability of an enterprise with an increase in the used share of borrowed capital leads to an increase in the risk of bankruptcy. This forces lenders to increase the level of the loan rate, taking into account the increasing premium for additional financial risk. With a high financial leverage ratio (at which the use of borrowed capital does not increase the return on equity), the differential will be reduced to zero.

In some cases, the financial leverage differential takes a negative value, at which the return on equity will decrease (part of the profit generated by equity is spent on paying off high interest rates for loans).

Thus, increasing the financial leverage ratio (raising additional borrowed capital) is advisable provided that the differential is greater than zero. A negative value of the financial leverage differential leads to a decrease in return on equity. In this case, they either reduce the cost of attracting borrowed capital or refuse to use it.

Calculation of the effect of financial leverage makes it possible to determine the financial structure of capital from the standpoint of its beneficial use, i.e. identify the maximum share of the use of borrowed capital for each specific enterprise. However, the calculated indicator of the maximum share of the use of borrowed capital does not always correspond to the mentality of financial managers in terms of the acceptable level of risk of reducing the financial stability of the enterprise. From these positions, the threshold for the maximum share of the use of borrowed funds when forming the capital structure can be lowered.

Synonyms

financial leverage

Was the page helpful?

More found about financial leverage

For any enterprise, the priority rule is that both own and borrowed funds must provide a return in the form of profit.

If an enterprise uses both its own and borrowed capital in production and trading activities, then the return on equity capital can be increased by attracting bank loans. In the theory of financial management, such an increase in return on equity is called the effect of financial leverage (leverage). The effect of financial leverage is an increase in the return on equity capital obtained by attracting a loan, despite its payment and payment of income tax. Obviously, this effect arises from the discrepancy between return on assets and the “price” of borrowed capital, that is, the average bank rate. In other words, the enterprise must provide such a return on assets that there will be enough cash to pay interest on the loan and pay income taxes.

If Return on assets(investment) or ROI(Return on investment)=

=Profit / Total assets,

Return on equity or ROE(Return on shareholders’ equity) =

= Profit/Equity,

then the relationship between return on equity and economic profitability can be expressed as follows:

Return on equity = Return on assets (economic profitability) x Financial leverage,

where Financial leverage = Total assets/Equity

As one of the indicators of business riskiness, the coefficient of financial dependence (financial leverage) determines the maximum volume of borrowings in accordance with the requirements of maintaining an acceptable level of financial stability of the enterprise. The lower the financial leverage, the more stable the financial position. The higher its value, the more risky the business is from the perspective of shareholders, investors and creditors. A high value of the financial dependence ratio can only be afforded by firms that have a stable and predictable flow of money for their products or enterprises that have a large share of liquid assets (trading enterprises, banks). Thus, in the meaning of the financial stability indicator, the financial dependence coefficient takes into account the financial risk accompanying the use of borrowed sources.

Financial leverage is the ratio of assets to equity capital. The higher it is, the greater the share of borrowed capital and the financial risk of the organization , because for a stable financial condition, the value of financial leverage should be less than 1.7.

On the other hand, as can be seen from the extended model of the company " Du Pont» borrowed capital allows you to increase the return on equity ratio, i.e. get additional profit on your own capital. The level of return on your own investments is affected by return on sales, asset turnover and the structure of advanced capital. The relationship between the level of return on equity and the above factors can be expressed using a modified or expanded formula of the company “ Du Pont", which looks like this:

Where: ROS– profitability of sales; AT(Assets Turnover) – asset turnover ratio; M (Equity multiplier) – equity multiplier (financial leverage or financial dependence ratio).

The equity multiplier characterizes the structure of the enterprise's funds and is determined by the ratio of the average annual amount of all funds of the enterprise ( T.A.) to the average annual amount of own funds ( E):

Where ( Financial leverage– financial leverage ratio, determined by the ratio of borrowed capital ( D) to equity ( E).

In this case, it is necessary to take into account the relationships between factors that are not directly reflected in the model “ Du Pont" For example, based only on the mathematical formula of the model, it may seem that an infinite increase in financial leverage will lead to an equally infinite increase in return on equity. However, as the share of borrowed funds in the advanced capital increases, payments for using loans also increase. As a result, net profit decreases and return on equity does not increase. The effect of financial leverage will depend on the price of borrowing and its relationship with economic profitability.

From this it is clear that financial leverage has an ambiguous effect on the financial and economic condition of the enterprise. Its effect is multidirectional - an increase in return on equity capital and its rate, as a rule, leads to a loss of solvency.

Ø The effect of financial leverage occurs when an organization has debt that entails the payment of constant amounts. It affects the organization's net income, and thus the return on equity.

Ø Return on equity increases with increasing debt as long as the economic return on assets is higher than the interest rate on loans and borrowings.

Ø The effect of financial leverage is positive when the economic profitability ratio is higher than the interest rate on debt.

Ø The effect of financial leverage is negative when the economic profitability ratio is lower than the interest rate on the loan.

As a result, return on equity ( ROE) is made up of return on assets ( ROA) on net profit before interest ( EBI) and the effect of financial leverage ( DFL):

Hence, the magnitude of the financial leverage effect ( DFL) can be defined:

Financial leverage effect (Degree of financial leverage – DFL ) – an indicator reflecting 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%;

t – income tax rate, in relative terms;

ROA EBIT) V %;

r – interest rate on borrowed capital, in%;

D – borrowed capital;

E – equity.

The components of the financial leverage effect are presented in Fig. 1.

Fig.1. Calculation of the effect of financial leverage

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 to what extent the effect of financial leverage is manifested in connection with different levels of income taxation.

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

Where: Diff - financial leverage differential in %;

r – interest rate on borrowed capital, in%.

ROA return on assets (economic profitability by EBIT) in%, calculated by the formula:

Where: EBIT– profit before taxes and interest (operating profit).

The financial leverage differential is the main condition that forms the growth of return on equity. To do this, it is necessary that economic profitability exceeds the interest rate of payments for using 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 enterprise.

The second component of the formula for the effect of financial leverage is financial leverage ratio (leverage leverage – FLS) , characterizing the strength of the impact of financial leverage and 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 leverage.

The differential and the 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, return on equity will grow faster the higher the debt-equity ratio. However, as the share of borrowed funds increases, their price increases, profits begin to decline, as a result, the return on assets also falls and, consequently, there is a threat of a negative differential.

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

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

Table 5

Calculation of the effect of financial leverage

The calculation results presented in Table 5 show that by attracting borrowed capital, the organization was able to increase return on equity by 15.2%.

Substituting the data in Table 5 into the above formulas for calculating the effect of financial leverage in various ways, we obtain the same result:

1 way.

Method 2.

11. Diagnosis of the probability of bankruptcy

A wide variety of methods and techniques for predicting bankruptcy have been studied in the domestic literature. For example, Bobyleva A.Z. identifies the following analysis methods applicable in predicting bankruptcy:

1. Trend analysis. It allows you to identify trends in changes in the most important indicators of an enterprise’s performance over several periods. However, in Russian conditions such an analysis is difficult. This is explained by the fact that comparison over a number of years is hampered by fairly frequent changes in accounting policies at enterprises, constant adjustments to tax and related legislation, and inflation.

2. Factor analysis. This method of analysis allows us to identify what caused the change in the financial results of the company. Among the most well-known factor models is the DuPont model.

3. Method based on the use of financial ratios. This method is the most common and publicly available. As a rule, it consists of studying the dynamics of financial ratios for a particular company, intercompany comparisons and comparison with general standards.

4. Methods of mathematical modeling and forecasting using computer programs. Such methods are mainly used in scientific work and large corporations.

Recently, simplified standard software products have appeared that allow formal financial analysis of basic reporting forms. The technical creation of such programs is not difficult. As a rule, it is enough to be able to work in Excel.

I.L. Yurzinova conventionally divides bankruptcy forecasting methods into static and pseudodynamic.

Static methods - various options for factor analysis using weighting coefficients. The general calculation formula for methods belonging to this group can be presented as follows:

Y is the resulting indicator;

N is the number of factors selected for analysis;

Xi - value of i-ro factor;

Pi - multiplier for the i-th factor - some constant that can be

interpreted as a weighting coefficient (the degree of significance of the factor).

Such techniques include bankruptcy forecasting models developed by

Altman, the methods of Zaitseva, Saifullin and Kadykov and a number of others. Unlike static techniques pseudodynamic techniques, according to I.L. Yurzinova, do not imply obtaining a single resulting characteristic obtained as a result of the addition of the analyzed factors. The use of these techniques allows us to obtain a vector result that ensures the independence of the analysis of significant indicators, which contributes to obtaining more accurate estimates. A typical example of pseudo-dynamic methods for assessing the financial condition of a business entity is W. Beaver's bankruptcy forecasting model.

In foreign practice, as a rule, a different classification of bankruptcy forecasting methods is used. For example, they distinguish:

objective Z-methods. The method is based on the calculation of certain relationships between individual items of financial statements (financial ratios) and their linear combinations. Each coefficient is considered with a certain weight, derived empirically based on a survey of a large group of enterprises;

subjective A-methods. A-methods are based on expert, often scoring, assessment. Everything is taken into account: the business reputation of the company, the personality of the manager, competitiveness, etc.

Considering that different groups of indicators reflect different financial processes (liquidity is reflected by liquidity indicators, financial efficiency is determined by profitability indicators, the share of borrowed funds is determined by indicators of financial stability), it is advisable to be able to conduct a comprehensive analysis of the financial condition of an enterprise according to various criteria that determine its financial activities.

Many analysts were looking for a characteristic that would best reflect the financial activity of an enterprise, but it is now recognized that one such characteristic is clearly not enough.

Financial leverage(or leverage) is a method of influencing an organization’s profit performance by varying the volume and composition of long-term liabilities.

Financial leverage just reveals the essence of this phenomenon, since “leverage” is translated from English as “a device for lifting weights.”

The effect of financial leverage shows, is it really necessary to attract borrowed funds at the moment, because an increase in their share in the structure of liabilities will lead to an increase in the return on equity capital.

What does financial leverage consist of?

To calculate the impact that financial leverage has, an economic formula is used, which is based on three components:

Tax proofreader. Characterizes a change in the effect of financial leverage with a simultaneous increase in the volume of the tax burden. This indicator does not depend on the activity of the enterprise, since tax rates are regulated by the state, but the company’s financiers can play on changes in the tax adjuster if subsidiaries apply different tax policies depending on the territory or type of activity.
Financial leverage ratio. Another parameter of financial leverage is calculated by dividing borrowed funds by equity. Accordingly, it is this ratio that shows whether financial leverage will have a positive impact on the company’s activities, depending on what the resulting ratio is.
Financial leverage differential. The final measure of leverage can be obtained by subtracting the average interest paid on all loans from the return on assets ratio. The greater the value of this component, the more likely the possibility of a positive impact of financial leverage on the organization. By constantly recalculating this indicator, financiers can monitor the moment at which the return on assets begins to decline and intervene in the current situation in a timely manner.

The sum of all three components will show the volume of funds raised from outside that is necessary to obtain the required increase in profit.

How is financial leverage calculated? Calculation formula

Let's look at three ways to assess the impact of financial leverage(or leverage):

The first method is the most common. Here the effect is calculated according to the following scheme: the difference between the unit and the tax rate in fractional terms is multiplied by the difference in the return on assets ratio as a percentage and the average interest on loans paid. The resulting amount is multiplied by the ratio of borrowed and equity funds. Literally, the formula looks like this:

EFL = (1- SNP) x (KVRa – PC) x ZS/SS.

Thus, three options are possible the impact of financial leverage on the organization’s activities:

positive effect— KVR is higher than the average lending rate;
zero effect— return on assets and rate are equal;
negative effect, if the average interest rate on loans is lower than the CVR.

The second method is built on the same principle as the operating lever. The influence of financial leverage is described here through the rate of increase or decrease in net profit and the rate of change in gross profit. To obtain the value of the strength of financial leverage, the first indicator is divided by the second. This value will show how much profit after taxes and contributions depends on gross profit.
Another way to determine the impact of financial leverage is the ratio of the percentage changes in net income for each ordinary share due to a change in the net result of operating the investment.

Net result of investment exploitation is one of the indicators of a company’s financial performance, which is used in financial management abroad. In simple terms, this is earnings before taxes, fees and interest, or operating profit.

The third method determines the effect of financial leverage by determining the amount of interest by which the organization's net profit per non-preferred share will increase or decrease if operating profit changes by one percent.

Financial dependency ratio. How to calculate?

The financial dependence ratio (FDC) shows whether the company is dependent on external sources of financing and, if so, how dependent. In addition, the ratio helps to see the capital structure as a whole, that is, both debt and equity.

The coefficient is calculated using the following formula:

Financial dependence ratio = Sum of short-term and long-term liabilities / Sum of assets

After calculation under normal conditions, the coefficient is in the range of 0.5 ÷ 0.7. What does it mean:

Kfz = 0,5. This is the best result in which liabilities are equal to assets, and the financial stability of the company is high.
Kfz is equal to the value 0.6 ÷ 0.7. This is still an acceptable range of values for the financial dependence ratio.
Kfz< 0,5. Such values indicate the untapped capabilities of the company due to the fact that it is afraid to attract loans, thus increasing the profitability of its capital.
Kfz > 0.7. The financial stability of the company is weak because it is overly dependent on external loans.

The effect of financial leverage. Effect calculation

Financial leverage, or rather the effect of its influence, determines by what amount the percentage of profitability of the enterprise’s own assets will increase if funds are raised from outside.

Impact of financial leverage is the difference between the company's total assets and all loans.

Formula for calculating the effect of financial leverage has already been presented above. It includes indicators of the tax rate (TP), return on assets (Rakt), weighted average price of borrowed capital (CZS), cost of borrowed capital (LC) and equity capital (CC) means and looks like this:

EFL = (1- NP) x (Rakt – Zs) x ZS/SS.

The EFL value should be in the range from 0.33 to 0.5.

Financial leverage and profitability

The relationship between the concepts of “financial leverage” and “organizational profitability”, or more precisely, “return on equity capital”, has already been described previously.

To increase the profitability of its own funds, the company needs not only to attract, but also to properly manage borrowed capital. And how successfully the management of the enterprise does this will show the effect of financial leverage.

Leverage ratio

Behind the seemingly complex name lies only the ratio of the amount of borrowed funds and equity. There are several other names for this value, for example, financial leverage or debt ratio (from English “debt ratio”).

Based on the last name, it becomes clear that the ratio reflects the share that funds raised from outside occupy among all sources of the company’s funds.

There is a formula for calculating the financial leverage ratio:

, Where

D.R.– leverage ratio;
C.L.- Short-term liabilities;
LTL- long term duties;
E.C.- equity;
L.C.– total raised capital (sum of short-term and long-term borrowed funds).

The normal value of this coefficient is in the range from 0.5 to 0.8.

There are a few things to consider when calculating your leverage ratio:

When calculating, it would be better to take into account not the accounting data, and the market value of assets. This is due to the fact that large enterprises have a much higher market value of their own funds than their balance sheet value. If you use balance sheet indicators in the calculation, the coefficient will be incorrect.
Enterprises often have too high a financial leverage ratio, where the largest share of assets is occupied by liquid ones, for example, those of credit and trading organizations. Stable demand and sales guarantee them a stable flow of money, that is, a constant increase in the share of their own funds.

Financial leverage ratio

This indicator allows you to find out what percentage of borrowed capital is in the company's own funds, and, more simply, shows the ratio of the company's borrowed funds and its equity capital.

The coefficient is calculated according to the following formula:

KFR = Net borrowing / Amount of own funds

In other words, net borrowing- These are all the company's liabilities minus its liquid assets.

In this case, equity capital is represented by the amounts on the balance sheet that shareholders invested in the organization: this is the authorized capital or par value of shares, as well as reserves accumulated during the company’s activities.

Retained earnings of the enterprise from its very foundation, the revaluation of property objects is reserve accumulation.

Sometimes The financial leverage ratio can reach critical values:

Kfr ≥ 100%. This means that the amount of borrowed funds is at least equal to equity, and may even exceed it, which means that creditors bring much larger sums of money to the company than its own shareholders.
More than 200%. There are known cases when the CFR exceeded 250%. This situation already indicates the complete absorption of the company by its creditors, because most of the sources of funds consist of borrowed funds.

Such situations are not easy to get out of and extreme measures may be taken to reduce the leverage ratio and, accordingly, debt, for example, the sale of several of the company's main activities.

Financial leverage indicator

The essence of the financial leverage indicator is it is a measurement of a firm's financial risk. The leverage becomes longer if the company's leverage increases, and this, in turn, makes the financial condition more unstable and can threaten the company with serious losses.

But, at the same time, an increase in the share of funds raised from outside also increases profitability, only from own funds.

Financial analysis knows two ways to calculate financial leverage indicators(lever):

Coverage indicators.

This group of indicators allows you to evaluate, for example, interest coverage on debt payments. With this indicator, they compare gross profit and the costs of loan payments and look at how much profit in this case covers the costs.

Using loan obligations as a means of financing a company's assets.

The debt ratio, which is calculated by dividing the sum of all liabilities by the sum of all assets, shows how capable the company is of repaying existing loans and obtaining new ones in the future.

A debt ratio that is too high indicates that the company has too little financial flexibility and has low assets with large debts.

Conclusion

So, financial leverage- this is an opportunity for a company to manage the profit received by changing the volume and structure of capital, both own and borrowed.

Entrepreneurs resort to the effect of financial leverage when they plan to increase the company's income.

In this case they attract credit money, replacing their own funds with it.

But we should not forget that an increase in a company’s liabilities always entails an increase in the level of financial risks of the organization.

For the convenience of studying the material, we divide the article financial leverage into topics:

An indicator reflecting the level of additional profit when using borrowed capital is called the effect of financial leverage.

It is calculated using the following formula:

EGF = (1 - Sn) x (KR - Sk) x ZK/SK,
Where:
EGF - effect of financial leverage, %.
Сн - rate, in decimal expression.
KR - asset ratio (ratio of gross profit to average asset value), %.
Sk - average interest rate for a loan, %. For a more accurate calculation, you can take the weighted average rate per loan.
ZK - the average amount of borrowed capital used.
SK is the average amount of equity capital.

(1-Сн) - does not depend on the enterprise.

(KR-Sk) - the difference between return on assets and the interest rate for the loan. It is called differential (D).
(ZK/SC) - financial leverage (LF).

Let us write down the formula for the effect of financial leverage in short:

EGF = (1 - Сн) x D x FR.

We can draw 2 conclusions:

The efficiency of using borrowed capital depends on the relationship between return on assets and the interest rate for the loan. If the loan rate is higher than the return on assets, the use of borrowed capital is unprofitable. - All other things being equal, greater financial leverage gives a greater effect.

Financial leverage effect

Managing profit generation involves the use of appropriate organizational and methodological systems, knowledge of the basic mechanisms of profit generation and modern methods of its analysis and planning. When using a bank loan or debt securities, the interest rates and the amount of debt remain constant during the term of the loan agreement or the maturity of the securities. related to debt servicing 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 included in (operating expenses), the use of debt as a source of financing is cheaper for the enterprise than other sources for which payments are made from (for example, 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 influence on. One of the main mechanisms for achieving this goal is financial leverage.

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

The idea of financial leverage according to the American concept is to assess the level of risk based on fluctuations in net profit caused by the constant cost of the enterprise to service debt. Its effect is manifested in the fact that any change in operating profit (earnings before interest and taxes) generates a more significant change in net profit.

Interpretation of the leverage ratio: it shows how many times earnings before interest and taxes exceed net income. The lower limit of the coefficient is unity. The greater the relative volume of borrowed funds attracted by an enterprise, the greater the amount of interest paid on them, the higher the power of financial leverage, and the more variable the net profit. Thus, an increase in the share of borrowed financial resources in the total amount of long-term sources of funds, which by definition is equivalent to an increase in the power of financial leverage, ceteris paribus, leads to greater financial instability, expressed in less predictability of net profit. Since the payment of interest, unlike, for example, the payment of dividends, is mandatory, then with a relatively high level of financial leverage, even a slight decrease in the profit received can have unfavorable consequences compared to a situation where the level of financial leverage is low.

The higher the impact of financial leverage, the more non-linear the relationship between net profit and profit before interest and taxes becomes. A small 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 level of the enterprise associated with a possible lack of funds to pay interest on loans and borrowings. For two enterprises with the same production volume, but different levels of financial leverage, the variation in net profit due to changes in production volume is not the same - it is greater for the enterprise with a higher level of financial leverage.

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

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

- financial leverage differential (ra-Ts,k), characterizing the difference between the profitability of the enterprise’s assets and the weighted average calculated interest rate on loans and borrowings;
- leverage of financial leverage ZK/SK

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

EGF=((1-Np)*(Ra – Tsk/1+i)*ZK/SK,
where i is a 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 differentiated tax rates are established for various types of activity of the enterprise;
- if the enterprise uses income tax benefits for certain types of activities;
- if individual subsidiaries of the enterprise operate in free economic zones of their country, where a preferential income tax regime applies, as well as in foreign countries.

In these cases, by influencing the sectoral or regional structure of production and, accordingly, the composition of profit according to the level of its taxation, it is possible, by reducing the average rate of profit taxation, to reduce the impact of the tax corrector of financial leverage on its effect (all other things being equal).

The financial leverage differential is a condition for the occurrence of the financial leverage effect. Positive EFR occurs in cases where the return on total capital (Pa) exceeds the weighted average price of borrowed resources (CP).

The difference between the return on total capital and the cost of borrowed funds will increase the return on equity. Under such conditions, it is beneficial to increase financial leverage, i.e. the share of borrowed funds in the capital structure of the enterprise. If Ra is less than Tsk, a negative EGF is created, resulting in a decrease in return on equity, which ultimately can cause.

The higher the positive value of the financial leverage differential, the higher, other things being equal, its effect.

Due to the high dynamics of this indicator, it requires constant monitoring in the process of profit management.

This dynamism is due to a number of factors:

Just like other exporting countries, Russia uses a wide arsenal of means to regulate international credit relations - these are tax and customs benefits, government guarantees and subsidized interest rates, subsidies and loans. However, to a greater extent, the Russian state supports large corporations and banks, which, as a rule, have substantial state participation, that is, itself. But medium and small businesses get little from the flow of benefits pouring onto large businesses. On the contrary, loans for the purchase of imported equipment are provided to small and medium-sized companies that are not included in small business support programs on significantly more stringent conditions than for large businesses.

The exchange rate and the direction of movement of global capital are also affected by the difference in interest rates in different countries. Raising interest rates stimulates the influx of foreign capital into the country and vice versa, and the movement of speculative, “hot” money increases the instability of balances of payments. But regulation of interest rates is unlikely to be productive due to the need to control liquidity, and therefore may hinder. At the same time, the Central Bank reduced the rate of contributions to the Mandatory Reserve Fund for ruble deposits. This measure is justified by the fact that in Europe mandatory reserve standards are lower, and Russian banks find themselves in unequal conditions.

Financial leverage profitability

The financial leverage effect (FLE) shows by what percentage the return on equity capital increases due to the attraction of borrowed funds into the turnover of the enterprise and is calculated by the formula:

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

Where Np is the income tax rate, in fractions of units;
Рп - 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;
Tsk - weighted average price of borrowed capital, in fractions of units;
ZK - average annual cost of borrowed capital; SC - average annual cost of equity capital.

The above formula for calculating the effect of financial leverage has three components:

Tax corrector of financial leverage (l-Нп), which shows to what extent the effect of financial leverage is manifested in connection with different levels of profit taxation;
- financial leverage differential (ra-Ts,k), characterizing the difference between the profitability of the enterprise’s assets and the weighted average calculated interest rate on loans and borrowings;
- leverage of financial leverage ZK/SK

Operating and financial leverage

The concept of “leverage” comes from the English “leverage - the action of leverage”, and means the ratio of one value to another, with a slight change in which the indicators associated with it change greatly.

The most common types of leverage are:

Production (operational) leverage.
Financial leverage.

All companies use financial leverage to one degree or another. The whole question is what is the reasonable ratio between equity and debt capital.

The financial leverage ratio (leverage of financial leverage) is defined as the ratio of debt capital to equity capital. It is most correct to calculate it based on the market valuation of assets.

The effect of financial leverage is also calculated:

EGF = (1 - Kn)*(ROA - Tsk) * ZK/SK.
where ROA is the return on total capital before taxes (the ratio of gross profit to the average value of assets)%;
SK - average annual amount of equity capital;
Кн - taxation coefficient, in the form of a decimal fraction;
Tsk - weighted average price of borrowed capital, %;
ZK - average annual amount of borrowed capital.

The formula for calculating the effect of financial leverage contains three factors:

(1 - Kn) - does not depend on the enterprise.
(ROA - Tsk) - the difference between return on assets and the interest rate for the loan. It is called differential (D).
(ZK/SC) - Financial leverage (LF).

You can write the formula for the effect of financial leverage in short:

EGF = (1 - Kn) x D x FR.

The effect of financial leverage shows by what percentage the return on equity increases due to the attraction of borrowed funds. The effect of financial leverage occurs due to the difference between return on assets and the cost of borrowed funds. The recommended EGF value is 0.33 - 0.5.

The resulting effect of financial leverage is that the use of debt, ceteris paribus, leads to the fact that the growth of corporate earnings before interest and taxes leads to a stronger increase in earnings per share.

The effect of financial leverage is also calculated taking into account the effects of inflation (debts and interest on them are not indexed). As the inflation rate increases, the fee for using borrowed funds becomes lower (interest rates are fixed) and the result from their use is higher. However, if interest rates are high or the return on assets is low, financial leverage begins to work against the owners.

Leverage is a very risky business for those enterprises whose activities are cyclical in nature. As a result, several consecutive years of low sales can push highly leveraged businesses into bankruptcy.

For a more detailed analysis of changes in the value of the financial leverage ratio and the factors that influenced it, use the 5-year financial leverage ratio method.

Thus, financial leverage reflects the degree of dependence of the enterprise on creditors, that is, the magnitude of the risk of loss of solvency. In addition, the company has the opportunity to take advantage of a “tax shield”, since, unlike dividends on shares, the amount of interest on the loan is deducted from the total profit subject to taxation.

Operating leverage (operating leverage) shows how many times the rate of change in sales profit exceeds the rate of change in sales revenue. Knowing the operating leverage, you can predict changes in profit when revenue changes.

It is the ratio of a company's fixed to variable expenses and the effect that ratio has on earnings before interest and taxes (operating profit). Operating leverage shows by what percentage profit will change if revenue changes by 1%.

Price operating leverage is calculated using the formula:

Rts = (P + Zper + Zpost)/P =1 + Zper/P + Zper/P
where: B - sales revenue.
P - profit from sales.
Zper - variable costs.
Postage - fixed costs.
Рс - price operating leverage.
pH is a natural operating lever.

Natural operating leverage is calculated using the formula:

Rn = (V-Zper)/P

Considering that B = P + Zper + Zpost, we can write:

Рн = (P + Zpost)/P = 1 + Zpost/P

Operating leverage is used by managers to balance various types of costs and increase revenue accordingly. Operating leverage makes it possible to increase profits when the ratio of variable and fixed costs changes.

By participating in the formation and use of funds of monetary resources, financial levers should influence the economic activities of economic entities, stimulate economic growth, increase labor productivity, improve product quality, and perform all other tasks related to the organization of production in terms of commercial calculation. The impact of financial levers on the development of social production depends on the functions with which they are endowed and on the implementation of these functions in practice. Thus, historical experience shows that taxes, when applied correctly, bring enormous benefits to the state, and when applied incorrectly, they cause irreparable harm. Even the technical aspect in tax practice plays a very important role. A classic example of this in the history of the Soviet economy is the fact that surplus appropriation was replaced by a tax in kind. As a result of this, the tax began to be levied in a different form and this led to positive results, although the severity of the taxation remained almost at the same level. Hence the conclusion - all financial levers require the most careful attention both during their development and during application.

The system of financial incentives, which are levers of influence on social production, plays an important role in both production and non-production activities. The transformation of finance into an instrument that ensures the organic inclusion of commodity-money relations in the mechanism of managing a market economy, strengthening the impact of finance on production in modern economic conditions occurs through the improvement of all forms of financial relations, including through the activation of financial incentives - rewards for good performance and application of sanctions for violations.

Various types of incentives expressing the content of the financial mechanism can be used in the formation of income, savings and funds. A wide range of different benefits are provided for taxes levied on the budget through partial or complete exemption of enterprises from their payment. The purpose of the incentive is to increase funds allocated for activities related to the development of production, the social needs of workers, environmental actions, charitable purposes, and the expansion of production of certain types of products (works, services). If income is concealed or paid late, various types of sanctions are applied, both economic and administrative, up to and including criminal liability.

Benefits and sanctions are also applied when organizing financing and lending for the production activities of enterprises and organizations of all forms of ownership. For example, they can be applied for inappropriate use of funds or late repayment of bank loans.

The development of quantitative parameters of each element of the financial mechanism is also important, i.e., the determination of rates, norms and standards for the allocation and withdrawal of funds, the volume of individual funds, the level of expenditure of financial resources, etc.

One of the fundamental principles of the activities of legislative and executive bodies related to the use of financial levers and incentives, the development of norms and standards, is the prompt accounting of changes in economic processes and timely influence on them, aimed at increasing the efficiency of economic development of the state.

The effect of financial leverage

Financial risk, entrepreneurial, production, risk associated with the activities of the company. The level of the conjugate effect of financial and operating leverage. The total risk associated with the firm. Types of risk, methods of determining risk. Risk management (regulation) using economic and financial methods. Relationships between owners and managers. Risk arising from the activities of owners. Economic, financial and other ways to minimize the risk associated with shareholders. A manager's ability to report at a shareholder meeting is an important lever for reducing overall risk. Net earnings per share.

It is a probabilistic and uncertain process. Therefore, it is extremely important to know the answer to the question: how likely is an entrepreneur to achieve his goals? It can be answered only taking into account the riskiness of the project, i.e., determining a quantitative measure of risk associated with a given enterprise and a specific investment project (more on this later).

We have already said earlier that the action of financial leverage inevitably creates a certain risk (financial) associated with the activities of the company; the action of production (operational) leverage also creates a risk (production) associated with the activities of the company. Consequently, it seems logical to conclude that with a more accurate examination of the enterprise’s activities, the summation of financial and production risks occurs.

Financial risk arising from the activity of financial leverage appears in the form of the risk of obtaining a negative differential value (then not only will there be no increase in the profitability of equity, but it will decrease) and the risk of reaching such a leverage value when it becomes impossible to pay interest on loans and current debt (there is an erosion of trust in the company on the part of creditors and other economic entities with catastrophic consequences for it).

The quantitative measure of financial risk is determined by the optimal values of the parameters of financial leverage. For the differential, the optimal value is associated with the ratio of the effect of financial leverage and return on equity. The quantitative value of this ratio ranges from 1/3 to 1/2. In this case, the value of the ratio of economic profitability and the average calculated interest rate must be greater than 1. From above, this ratio is limited by the possibilities for increasing the economic profitability of the company (these are objective factors of an economic and technological order).

For leverage, the optimal ratio of debt and equity for normally operating firms in the West is determined at 0.67. As mentioned above, for Russia today this ratio should be different. The reason is high inflation (by Western standards), which Russian firms perceive as a normal background for their business activities. As a result, the optimal leverage value is somewhere in the range of 1.5.

Obviously, in this case, the force of influence of financial leverage should be in the range from 4/3 to 3/2. This value was obtained as follows: starting from the optimal ratio of EFR and RSS, we transferred it to the share of interest payments on a bank loan in the balance sheet profit of the enterprise (do not forget that we are trying to determine a certain limiting value of the power of financial leverage as a quantitative expression of financial risk) . This gave us the opportunity to determine a certain “good” position (the power of financial leverage is 4/3, i.e., up to 1/3 of the balance sheet profit goes to paying interest on loans) and a certain position, which we can call the “red line”, enter for which the company is undesirable (the power of financial leverage within 3/2, which requires the company to pay 1/2 of balance sheet profit as interest on loans).

In a similar way, we will try to determine the limiting value of the effect of production leverage. Let us recall that it shows by how many percentage points profit will increase (decrease) when revenue increases (decreases) by 1%. It should be noted that each industry has its own operating conditions, determined by economic, technological, and other reasons. Therefore, it is unlikely that it will be justified to determine a single quantitative value of the production leverage effect to calculate the degree of risk associated with the entrepreneurial (non-financial) activity of a company.

Most likely, we should be talking about some kind of “framework”. On the one hand, this will be the volume of production corresponding to the profitability threshold, on the other hand, the volume of production of these goods, which will require a one-time increase in fixed costs.

It is unsafe for a company to be both at the threshold of profitability and at a position where it is no longer possible to increase production without increasing fixed costs. Both of these provisions involve the risk of significant loss of profits. It is known that the closer the company is to the profitability threshold, the greater the impact of the production lever (and this is a risk!). It is equally risky to “sleep through” the period of growth in fixed costs, calming down due to the significant amount of financial safety margin.

Thus, the company faces a dilemma: either high rates of production growth and the approaching period of a one-time increase in fixed costs, or a slow increase in production, which makes it possible to “push back” the period of a one-time increase in fixed costs. In the second case, the company must be sure that its product will be in demand for a long time.

Now about the role of fixed costs in determining production (business) risk. Let us recall that the large share of fixed costs that interests us is an objective requirement of technology (for example, capital-intensive production of ferrous metals).

Let's look at a simple example. We have two companies that differ only in the share of fixed costs:

First: revenue - 1200, fixed costs - 500, variable costs - 500, profit - 200.
Second: revenue - 1200, fixed costs - 100, variable costs - 900, profit - 200.
The strength of the production lever for the first company is 3.5, for the second company it is 1.5.

Consequently, the higher the share of fixed costs, the greater the impact of the production lever, and, consequently, the business risk associated with this company, and vice versa.

Everyone knows (this has already been said above) that in the real activities of a real company, financial and business risks are summed up. In financial management, this is expressed in the concept of the conjugate effect of financial and production leverage:

The level of the conjugate effect of financial and operating leverage = the strength of the financial leverage x the strength of the operating leverage

In fact, this indicator provides an assessment of the total risk associated with a given enterprise. Unfortunately, we will not be able to give an accurate quantitative assessment of it; we will limit ourselves to only “framework” estimates.

So, the power of influence of financial leverage increases during the period of development of new products (the period of increasing production and reaching the profitability threshold) and during the period of abandoning the production of this product and the transition to the production of a new one (the period when there is a sharp increase in fixed costs). Consequently, during this period the financial risk associated with the company increases (a sharp increase in borrowing).

Production (entrepreneurial) risk increases during the same periods of the company's activity. Consequently, the overall risk associated with the enterprise increases in two cases: reaching the threshold of profitability and a sharp increase in fixed costs due to the need to develop new products. All that remains is to accurately determine the beginning of these periods! This will be the “universal” recipe for reducing the overall risk!

To determine the risk associated with a company, it is necessary to use not only the values of the strength of financial and operational leverage, but also be able to measure risk by determining the average expected value of the magnitude of the event and the variability (variability) of the possible result.

Science has also developed ways to reduce risks (financial and production). We will not specifically consider this issue in detail in this manual. We will just list these methods: production, obtaining additional and reliable information, risk insurance, limiting expenses, etc. We see that among them there are both economic and financial ways to reduce the risk associated with the company.

In the framework of this work, I would like to dwell in more detail on one specific form of risk generated by the actions of shareholders. It seems that it should be the focus of attention of enterprise managers. To overcome it, you can use traditional forms of risk reduction (see above), but there is a fundamentally important aspect for the financial manager.

It is clear that owners and managers have different interests, including economic ones. If the main criterion for a shareholder’s activity is maximizing income (profit) per share and the growth of its value, then managers strive to increase the sustainability of the enterprise they manage, i.e., most likely, they gravitate toward setting and implementing long-term (strategic) goals, unlike shareholders, usually based on setting short-term goals.

Another very important point for a manager related to shareholders is that the risk emanating from shareholders is the most dangerous for the company. It is difficult to imagine what could happen to a company in the event of a panic among shareholders, who are not always as economically literate as managers. Shareholders react more easily to rumors that may be deliberately spread by unscrupulous competitors. Their (shareholders') behavior is very difficult to regulate, since they are the owners, and managers are only hired managers. Therefore, the question of neutralizing shareholders becomes fundamental for managers. By solving it, they will be able to reduce or even eliminate the risk associated with shareholder behavior.

In this regard, the role of the general meeting of shareholders and the report of the company's managers at it increases immeasurably (the financial section here is the most important because it is written in a language understandable to shareholders - income, expenses, profits, losses, etc.). Shareholders are especially interested in net earnings per share in the future period (let's not forget, we must neutralize shareholders, at least until the next shareholders meeting).

So, net earnings per share in the future period are determined as follows:

Net earnings per share in the future period = Earnings per share in the current period x (1 + the level of the associated effect of financial and operating leverage) x Percentage change in revenue from sales of products

In the formula, the last multiplier - the percentage change in revenue from product sales - is determined according to the rules we have already formulated (see above), so financial managers have a tool that allows them to reassure shareholders. Obviously, if revenue growth is planned in the next period, this will have a positive impact on the amount of net profit per share in the future period. A calm shareholder is actually a neutralized shareholder.
|