What is the effect of financial leverage. Financial leverage (financial leverage)

For any enterprise, the priority is the rule that both own and borrowed funds must provide a return in the form of profit. The action of the financial leverage (leverage) characterizes the feasibility and efficiency of the use of borrowed funds by the enterprise as a source of financing of economic activity.

Financial Leverage Effect (E.F.R.) is that the company, using borrowed funds, changes the net profitability of own funds. This effect arises from the discrepancy between the profitability of assets (property) and the "price" of borrowed capital, i.e. average bank rate. At the same time, the enterprise must provide for such a return on assets so that Money was enough to pay interest on the loan and pay income tax.

It should be borne in mind that the average calculated interest rate does not coincide with the interest rate accepted under the terms of the loan agreement. Average settlement rate set according to the formula:

where: joint venture- the average settlement rate for a loan; FI to– actual financial costs for all loans received for billing period(amount of interest paid); AP amount – total amount borrowed funds attracted in the billing period.

General formula for calculating the effect of financial leverage (EFF) can be expressed:

where: H– income tax rate in fractions of a unit; R A– economic return on assets (based on the amount of profit before taxes and interest on loans); joint venture- average calculated interest rate for a loan in %; ZK – borrowed capital; SC- equity.

1. tax corrector (1–H), shows the extent to which E.F.R. due to different levels of taxation. It does not depend on the activities of the enterprise, because income tax rate is approved by law.

In the process of managing F.R. A differentiated tax corrector may be used in cases where: 1) various types activities of the enterprise differentiated tax rates are established; 2) by certain types activities of the enterprise use income tax benefits; 3) individual subsidiaries (branches) of the enterprise carry out their activities in free economic zones both in their own country and abroad.

2. Lever differential (R A -SP) characterizes the difference between economic profitability and the average interest rate for a loan, i.e. it is the main factor that forms a positive E.F.R. value. Condition R A >SP specifies a positive E.F.R., i.e. the use of borrowed capital will be beneficial for the enterprise. The higher the positive value of the differential, the more significant, all other things being equal, the value of E.F.R.

Due to the high dynamism of this indicator, it requires systematic monitoring in the management process. The dynamism of the differential is due to a number of factors: (1) during a period of deterioration in the financial market, the cost of raising borrowed funds may increase sharply and exceed the level of accounting profit generated by the assets of the enterprise; (2)reduction financial stability, in the process of intensive attraction of borrowed capital, leads to an increase in the risk of bankruptcy of the enterprise, which makes it necessary to increase interest rates for a loan, taking into account the premium for additional risk. Differential F.R. then it can be reduced to zero or even to a negative value, as a result, profitability equity will decrease, because part of the profit it generates will be used to service the debt received at high interest rates; (3) during the period of deterioration in the situation on the commodity market, reduction in sales and accounting profit, a negative value of the differential can form even at stable interest rates due to a decrease in the return on assets.

The negative value of the differential leads to a decrease in the return on equity, which makes its use inefficient.

3. financial leverage (coefficient of financial dependence KFZ) reflects the amount of borrowed capital used by the organization per unit of equity. It is a multiplier that changes the positive or negative value of the differential.

When positive nom value of the differential, any increase in K.F.Z. will lead to an even greater increase in the return on equity. At negative value differential gain K.F.Z. will lead to an even greater drop in the return on equity.

So, with a stable differential K.F.Z. is the main factor influencing the amount of return on equity, i.e. it generates financial risk. Similarly, with a constant value of K.F.Z, a positive or negative value of the differential generates both an increase in the amount and level of return on equity, and the financial risk of its loss.

Combining the three components of the effect (tax corrector, differential and C.F.Z.), we get the value of E.F.R. This method of calculation allows the company to determine the safe amount of borrowed funds, that is, acceptable lending conditions.

To implement these favorable opportunities, it is necessary to establish the relationship and contradiction between the differential and the coefficient of financial dependence. The fact is that with an increase in the amount of borrowed funds, the financial costs of servicing the debt increase, which in turn leads to a decrease positive value differential (with a constant value of return on equity).

From the foregoing, the following conclusions can be drawn: (1) if a new borrowing brings an increase in the level of E.F,R to an enterprise, then it is beneficial for the enterprise. At the same time, it is necessary to control the state of the differential, since with an increase in the debt ratio, a commercial bank is forced to compensate for the increase in credit risk by increasing the “price” of borrowed funds; (2) the creditor's risk is expressed by the value of the differential, since the higher the differential, the lower the bank's credit risk. Conversely, if the differential becomes less than zero, then the leverage effect will act to the detriment of the enterprise, that is, there will be a deduction from the return on equity, and investors will not be willing to buy shares of the issuing enterprise with a negative differential.

Thus, an enterprise's debt to a commercial bank is neither good nor evil, but it is its financial risk. By attracting borrowed funds, an enterprise can more successfully fulfill its tasks if it invests them in highly profitable assets or real investment projects with a quick return on investment. The main task for the financial manager is not to eliminate all risks, but to accept reasonable, pre-calculated risks, within the positive value of the differential. This rule is also important for the bank, because a borrower with a negative differential is distrustful.

The second way to calculate E.F.R. can be viewed as a percentage (index) change in net profit per ordinary share, and the fluctuation in gross profit caused by this percentage change. In other words, E.F.R. is determined by the following formula:

where ∆P F A- percentage change in net profit per ordinary share; ∆P V A- percentage change in gross earnings per ordinary share

The smaller the impact of financial leverage, the lower the financial risk associated with this enterprise. If borrowed funds are not involved in circulation, then the force of the financial leverage is equal to 1.

The greater the impact of financial leverage, the higher the company's level financial risk in this case: (1) for commercial bank the risk of non-repayment of the loan and interest on it increases; (2) for the investor, the risk of a decrease in dividends on the shares of the issuing enterprise owned by him increases from high level financial risk.

The second method of measuring the effect of financial leverage makes it possible to perform an associated calculation of the strength of the impact of financial leverage and establish the total (general) risk associated with the enterprise.

In inflationary conditions, if debt and interest on it are not indexed, E.F.R. increases as debt service and debt itself are paid for with already depreciated money. It follows that in an inflationary environment, even with a negative value of the differential of financial leverage, the effect of the latter can be positive due to non-indexation of debt obligations, which creates additional income from the use of borrowed funds and increases the amount of equity capital.

Leverage (from English leverage) has the following meanings:

proportion, the ratio of capital investments in fixed income securities, such as bonds, preferred shares, and investments in non-fixed income securities, such as ordinary shares;

the ratio of the stock of goods and the amount of capital;

the ratio of a company's capital to borrowed funds.

Possible spelling of the term - leverage, leverage - Lozovsky L.Sh., Raizberg B.A., Ratnovsky A.A. Universal Business- vocabulary. - M.: INFRA - M., 1997. - p. 190.

Leverage- use of borrowed funds with a fixed interest to increase the profits of ordinary shareholders. Also known as the "principle of leverage" and generally describes the process of lending - Van Horn J.K. Fundamentals of financial management.: Per. from English. / Ch. ed. series Ya.V. Sokolov. - M.: Finance and statistics, 1996. - p. 449.

The effect of financial leverage- this is an increase in the return on equity, obtained through the use of a loan, despite the payment of the latter. - Financial management: theory and practice. Textbook / Under. ed. E.S. Stoyanova. - M .: Publishing house "Perspective", 1998. - p. 150.

From various definitions financial leverage (leverage), it can be seen that an additional effect from investing and operating funds in the course of the enterprise's activities can be obtained by using borrowed funds with a fixed interest rate. Such funds also include funds raised when issuing bonds and preferred shares, which also provide for the payment of fixed interest.

Consider an example of the effect of financial leverage.

Initial information:

According to the results of activities for 1999, the American company producing stationery under the name "Red Tape" was a success in the market of Eastern Europe. Her self-sharpening pencils were especially popular. The Eastern European market was not yet saturated with them, and in an effort to expand its influence in this sector as soon as possible before the arrival of competitors, the Red Tape company, represented by the administration, planned to purchase additional equipment for the production of self-sharpening pencils in early 2000, which would increase production capacity twice. This required an additional $1 million. Heated disputes broke out between the company's president, Walter, and the chairman of the Board of Directors, Stevens, over sources of funding. The gist of the disagreement was as follows:

Walter proposed to organize the issue of ordinary shares in the amount of $ 1 million in the amount of 10,000 shares with a par value of $ 100, which aroused the fears of Stevens, who had a controlling stake in Red Tape. Stevens feared losing control of the company, authorized capital which at the time of the dispute was $ 1 million, and Stevens' share in it was 52 percent (i.e., in the amount of $ 520 thousand). He understood that after issuing additional shares in the amount of $1 million, the authorized capital of the company would be $2 million, and his $520,000 would give him a share of 26 percent, which is not enough for a controlling stake.

Stevens proposed to organize the issue of corporate bonds in the amount of 1 million dollars in the amount of 10 thousand pieces with a face value of 100 dollars, since the size of the authorized capital does not change, which quite suits Stevens. This proposal outraged Walter, because, in his opinion, the issue of bonds, increasing the level of debt of the company as a whole, worsens the indicator of financial stability. Even Stevens' proposal to lower the dividend rate to the level of the bond interest rate (to 10 percent per annum) did not affect the opinion of Walter, who believes that this does not provide any gain for the company.

It is necessary, taking the position of Chairman of the Board of Directors Stevens, to prove that the issue increases the sources of financing for the Red Tape company compared to the issue of ordinary shares, given that:

1. The income tax rate is 0.5;

2. The total profitability of production (before interest and tax) is 20 percent per annum.

The results of the company's activities with various sources of financing, subject to the income tax rate of 0.5 and the overall profitability of production (before interest and tax) is 20 percent per annum, are presented in table 7.

Table 7. Financial results of the company

As can be seen from the above calculation, according to the Stevens option, the company at the end of the year will have additional funding$50,000 in retained earnings. This, in turn, raises the stock's return to 15 percent, which Stevens is naturally also interested in. There is an effect of financial leverage.

How does financial leverage work?

It is easy to see that this effect arises from the discrepancy between economic profitability and the "price" of borrowed funds - the average interest rate (AR). In other words, the enterprise must develop such economic profitability (ER) that the funds are sufficient, at least to pay interest on the loan. The average interest rate, as a rule, does not coincide with the interest rate mechanically taken from the loan agreement. A loan at 60 percent per annum for a period of 3 months (1/4 year) actually costs 15 percent.

Interest payments on loans can come from two main sources. First, they can be written off to the cost of products manufactured by the enterprise, within the limits of the Central Bank rate plus 3 percent. This part of the financial costs is not affected by taxes. The second source is profit after taxes. In this case, during the analysis, in order to obtain the actual financial costs, the corresponding amounts of interest must be increased by the amounts transferred to the state budget in the form of tax.

For example: the amount of interest paid at the expense of the profit remaining at the disposal of the enterprise is 100 thousand rubles.

The income tax rate is 35 percent.

Actual financial costs in terms of interest paid out of the profit remaining at the disposal of the enterprise - 135 thousand rubles.

In addition to formula (62), it is possible to calculate the average interest rate not by the arithmetic average, but by the weighted average cost of various credits and loans. It is also possible to classify as borrowed funds the money received by the enterprise from the issue of preferred shares. Some economists insist on this because a guaranteed dividend is paid on preferred shares, which makes this method of raising capital related to borrowing, and, moreover, in the liquidation of an enterprise, the owners of preferred shares have almost equal rights to what they are due with creditors. But in this case, the financial costs should include the amount of dividends, as well as the costs of issuing and placing these shares.

And if, for example, at the end of 1998, the standard for attributing interest to the cost of production was (60% + 3%) = 63%, and a loan was provided to an enterprise at 70% per annum, then, taking into account tax savings, such a loan cost the borrower (1 - 0, 35) 63% + (1 + 0.35) (70% - 63%) = 50.40%.

To calculate the effect of financial leverage, we single out the first component - this is the so-called differential, those. the difference between the economic return on assets (ER) and the average calculated interest rate (AP). Tax-adjusted, the differential is equal to or approximately 2/3 (ER-SP).

The second component is lever arm- characterizes the force of the lever. This is the ratio between borrowed and own funds. We combine both components of the leverage effect and get:

Take enterprise A, which has 250 thousand rubles. own and 750 thousand rubles. borrowed money. The economic return on assets for enterprise A is 20 percent.

Borrowed funds cost, say, 18 percent. For such an enterprise, the leverage effect will be

The first way to calculate the level of effect of financial leverage:

Based on the basic definition of the effect of financial leverage, the return on equity (RCC) will be determined by formula 65:

When using borrowed funds, two important rules should be remembered:

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

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.

Credit conditions with an indefatigable increase in borrowing may worsen.

Enterprise A, discussed above, with a leverage effect of 4 percent and a differential of 2 percent, with a rise in the cost of credit by only 1 percentage point, will have to increase leverage 6 to maintain the previous leverage.

EGF = 2/3 (20% - 19%) 6 = 4%.

To compensate for the increase in the cost of credit by only 1 percentage point, enterprise A is forced to double the ratio between borrowed and own funds.

Then a moment may come when the differential becomes less than zero. The leverage effect will then only be to the detriment of the enterprise if, for example, with a ninefold ratio of borrowed and own funds, it is necessary to pay an average rate of 22 percent on a loan, then the leverage effect and return on equity of enterprise A will be:

To identify the optimal ratios between the return on equity, the economic return on assets, the average interest rate and leverage, we construct graphs (Fig. 6).

It can be seen from these graphs that the smaller the gap between the Er and the average interest rate (MAR), the a large share have to be leveraged to raise the RCC, but this is not safe when the differential is lowered.

For example, to achieve a 33 percent ratio between the effect of leverage and RCC (when the success of an enterprise is 1/3 due to the financial side of the business and 2/3 due to production), it is desirable to have

leverage 0.75 at ER = 3SP

leverage 1.0 at ER = 2SP

lever arm 1.5 at ER = 1.5SP

Thus, ER = 3 SRSP

ER = 2 SRSP

ER = 1.5 SRSP

The second concept of the effect of financial leverage

The effect of financial leverage can also be interpreted as the percentage change in net income per ordinary share generated by a given percentage change in the net result of operating the investment (earnings before interest on loans and taxes). This perception of the effect of financial leverage is typical mainly for the American school of financial management.

According to the second concept of the effect of financial leverage, the strength of the impact of financial leverage is determined by formula 66:

This formula answers the question of what percentage will change net profit per ordinary share when the net result of investment operation changes by one percent.

Based on the fact that the net result of investment exploitation (NREI) can be calculated as the sum of balance sheet profit and financial costs on the loan, attributable to the cost of production, formula (66) can be transformed as follows:

Using this formula, the following conclusions can be drawn: the greater the force of financial leverage, the greater the financial risk associated with the enterprise:

1. The risk of non-repayment of a loan with interest for a banker increases.

2. The risk of a fall in the dividend and the share price for the investor increases.

For any enterprise, the priority is the rule that both own and borrowed funds must provide a return in the form of profit (income). The action of financial leverage (leverage) characterizes the expediency and efficiency of the use of borrowed funds by the enterprise as a source of financing of economic activity.

The effect of financial leverage is that the company, using borrowed funds, changes the net profitability of own funds. This effect arises from the discrepancy between the profitability of assets (property) and the "price" of borrowed capital, i.e. average bank rate. At the same time, the company must provide for such a return on assets so that the funds are sufficient to pay interest on the loan and pay income tax.

It should be borne in mind that the average calculated interest rate does not coincide with the interest rate accepted under the terms of the loan agreement. The average settlement rate is set according to the formula:

SP \u003d (FIk: amount of AP) X100,

joint venture - the average settlement rate for a loan;

Fick - actual financial costs for all loans received for the billing period (the amount of interest paid);

AP amount - the total amount of borrowed funds attracted in the billing period.

The general formula for calculating the effect of financial leverage can be expressed as:

EGF \u003d (1 - Ns) X(Ra - SP) X(GK:SK),

EGF - the effect of financial leverage;

Ns – income tax rate in fractions of a unit;

Ra – return on assets;

joint venture - average calculated interest rate for a loan in %;

ZK - borrowed capital;

SC - equity.

The first component of the effect is tax corrector (1 - Hs), shows the extent to which the effect of financial leverage is manifested in connection with different levels of taxation. It does not depend on the activities of the enterprise, since the income tax rate is approved by law.

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

differentiated tax rates have been established for various types of enterprise activities;

for certain types of activities, enterprises use income tax benefits;

individual subsidiaries (branches) of the enterprise operate in free economic zones, both in their own country and abroad.

The second component of the effect is differential (Ra - SP), is the main factor that forms the positive value of the effect of financial leverage. Condition: Ra > SP. The higher the positive value of the differential, the more significant, other things being equal, the value of the effect of financial leverage.

Due to the high dynamism of this indicator, it requires systematic monitoring in the management process. The dynamism of the differential is due to a number of factors:

in a period of deterioration in the financial market, the cost of raising borrowed funds may increase sharply and exceed the level of accounting profit generated by the company's assets;

the decrease in financial stability, in the process of intensive attraction of borrowed capital, leads to an increase in the risk of bankruptcy of the enterprise, which makes it necessary to increase interest rates for a loan, taking into account the premium for additional risk. The financial leverage differential can then be reduced to zero or even to a negative value. As a result, the return on equity will decrease, as part of the profit it generates will be used to service the debt received at high interest rates;

during a period of deterioration in the situation on the commodity market, a decrease in sales and the amount of accounting profit, a negative value of the differential can form even at stable interest rates due to a decrease in the return on assets.

Thus, the negative value of the differential leads to a decrease in the return on equity, which makes its use inefficient.

The third component of the effect is debt ratio or financial leverage (GK: SK) . It is a multiplier that changes the positive or negative value of the differential. With a positive value of the differential, any increase in the debt ratio will lead to an even greater increase in the return on equity. With a negative value of the differential, the increase in the debt ratio will lead to an even greater drop in the return on equity.

So, with a stable differential, the debt ratio is the main factor affecting the return on equity, i.e. it generates financial risk. Similarly, with the debt ratio unchanged, a positive or negative value of the differential generates both an increase in the amount and level of return on equity, and the financial risk of losing it.

Combining the three components of the effect (tax corrector, differential and debt ratio), we obtain the value of the effect of financial leverage. This method of calculation allows the company to determine the safe amount of borrowed funds, that is, acceptable lending conditions.

To realize these favorable opportunities, it is necessary to establish the relationship and contradiction between the differential and the debt ratio. The fact is that with an increase in the volume of borrowed funds, the financial costs of servicing the debt increase, which, in turn, leads to a decrease in the positive value of the differential (with a constant return on equity).

From the above, the following can be done findings:

if new borrowing brings to the enterprise an increase in the level of the effect of financial leverage, then it is beneficial for the enterprise. At the same time, it is necessary to control the state of the differential, since with an increase in the debt ratio, a commercial bank is forced to compensate for the increase in credit risk by increasing the “price” of borrowed funds;

the creditor's risk is expressed by the value of the differential, since the higher the differential, the lower the bank's credit risk. Conversely, if the differential becomes less than zero, then the leverage effect will act to the detriment of the enterprise, that is, there will be a deduction from the return on equity, and investors will not be willing to buy shares of the issuing enterprise with a negative differential.

Thus, an enterprise's debt to a commercial bank is neither good nor evil, but it is its financial risk. By attracting borrowed funds, an enterprise can more successfully fulfill its tasks if it invests them in highly profitable assets or real investment projects with a quick return on investment.

The main task for a financial manager is not to eliminate all risks, but to take reasonable, pre-calculated risks, within the positive value of the differential. This rule is also important for the bank, because a borrower with a negative differential is distrustful.

Financial leverage is a mechanism that a financial manager can master only if he has accurate information about the profitability of the company's assets. Otherwise, it is advisable for him to treat the debt ratio very carefully, weighing the consequences of new borrowings in the loan capital market.

The second way to calculate the effect of financial leverage can be viewed as a percentage (index) change in net profit per ordinary share, and the fluctuation in gross profit caused by this percentage change. In other words, the effect of financial leverage is determined by the following formula:

leverage strength = percentage change in net income per ordinary share: percentage change in gross income per ordinary share.

The smaller the impact of financial leverage, the lower the financial risk associated with this enterprise. If borrowed funds are not involved in circulation, then the force of the financial leverage is equal to 1.

The greater the force of financial leverage, the higher the company's level of financial risk in this case:

for a commercial bank, the risk of non-repayment of the loan and interest on it increases;

for the investor, the risk of reducing dividends on the shares of the issuing enterprise with a high level of financial risk that he owns increases.

The second method of measuring the effect of financial leverage makes it possible to perform an associated calculation of the strength of the impact of financial leverage and establish the total (general) risk associated with the enterprise.

In terms of inflation if the debt and interest on it are not indexed, the effect of financial leverage increases, since debt servicing and the debt itself are paid for with already depreciated money. It follows that in an inflationary environment, even with a negative value of the differential of financial leverage, the effect of the latter can be positive due to non-indexation of debt obligations, which creates additional income from the use of borrowed funds and increases the amount of equity 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 such 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 using 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- gross profitability ratio of assets (characterized by the ratio of gross profit to average cost assets), %;
• PC- the average amount of 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 more likely 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 lenders provide more financial resources for the operation of the company than the 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 report of the chairman of the board 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)- indicator 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 factor, the change of which can lead to a significant change in a number of performance indicators. This term is 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 the balance sheet of the organization. However, it is recommended to make calculations based on the market valuation of assets, and not data. financial statements. Since a successful enterprise market value equity capital may exceed the book value, which means a lower value of the indicator and a lower level of 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 effectiveness of production and marketing activities, optimal solutions 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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For any enterprise, the priority is the rule that both own and borrowed funds must provide a return in the form of profit (income). The action of financial leverage (leverage) characterizes the expediency and efficiency of the use of borrowed funds by the enterprise as a source of financing of economic activity.

The effect of financial leverage is that the company, using borrowed funds, changes the net profitability of own funds. This effect arises from the discrepancy between the profitability of assets (property) and the "price" of borrowed capital, i.e. average bank rate. At the same time, the company must provide for such a return on assets so that the funds are sufficient to pay interest on the loan and pay income tax.

It should be borne in mind that the average calculated interest rate does not coincide with the interest rate accepted under the terms of the loan agreement. The average settlement rate is set according to the formula:

SP \u003d (FIk: amount of AP) X100,

joint venture - the average settlement rate for a loan;

Fick - actual financial costs for all loans received for the billing period (the amount of interest paid);

AP amount - the total amount of borrowed funds attracted in the billing period.

The general formula for calculating the effect of financial leverage can be expressed as:

EGF \u003d (1 - Ns) X(Ra - SP) X(GK:SK),

EGF - the effect of financial leverage;

Ns – income tax rate in fractions of a unit;

Ra – return on assets;

joint venture - average calculated interest rate for a loan in %;

ZK - borrowed capital;

SC - equity.

The first component of the effect is tax corrector (1 - Hs), shows the extent to which the effect of financial leverage is manifested in connection with different levels of taxation. It does not depend on the activities of the enterprise, since the income tax rate is approved by law.

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

differentiated tax rates have been established for various types of enterprise activities;

for certain types of activities, enterprises use income tax benefits;

individual subsidiaries (branches) of the enterprise operate in free economic zones, both in their own country and abroad.

The second component of the effect is differential (Ra - SP), is the main factor that forms the positive value of the effect of financial leverage. Condition: Ra > SP. The higher the positive value of the differential, the more significant, other things being equal, the value of the effect of financial leverage.

Due to the high dynamism of this indicator, it requires systematic monitoring in the management process. The dynamism of the differential is due to a number of factors:

in a period of deterioration in the financial market, the cost of raising borrowed funds may increase sharply and exceed the level of accounting profit generated by the company's assets;

the decrease in financial stability, in the process of intensive attraction of borrowed capital, leads to an increase in the risk of bankruptcy of the enterprise, which makes it necessary to increase interest rates for a loan, taking into account the premium for additional risk. The financial leverage differential can then be reduced to zero or even to a negative value. As a result, the return on equity will decrease, as part of the profit it generates will be used to service the debt received at high interest rates;

during a period of deterioration in the situation on the commodity market, a decrease in sales and the amount of accounting profit, a negative value of the differential can form even at stable interest rates due to a decrease in the return on assets.

Thus, the negative value of the differential leads to a decrease in the return on equity, which makes its use inefficient.

The third component of the effect is debt ratio or financial leverage (GK: SK) . It is a multiplier that changes the positive or negative value of the differential. With a positive value of the differential, any increase in the debt ratio will lead to an even greater increase in the return on equity. With a negative value of the differential, the increase in the debt ratio will lead to an even greater drop in the return on equity.

So, with a stable differential, the debt ratio is the main factor affecting the return on equity, i.e. it generates financial risk. Similarly, with the debt ratio unchanged, a positive or negative value of the differential generates both an increase in the amount and level of return on equity, and the financial risk of losing it.

Combining the three components of the effect (tax corrector, differential and debt ratio), we obtain the value of the effect of financial leverage. This method of calculation allows the company to determine the safe amount of borrowed funds, that is, acceptable lending conditions.

To realize these favorable opportunities, it is necessary to establish the relationship and contradiction between the differential and the debt ratio. The fact is that with an increase in the volume of borrowed funds, the financial costs of servicing the debt increase, which, in turn, leads to a decrease in the positive value of the differential (with a constant return on equity).

From the above, the following can be done findings:

if new borrowing brings to the enterprise an increase in the level of the effect of financial leverage, then it is beneficial for the enterprise. At the same time, it is necessary to control the state of the differential, since with an increase in the debt ratio, a commercial bank is forced to compensate for the increase in credit risk by increasing the “price” of borrowed funds;

the creditor's risk is expressed by the value of the differential, since the higher the differential, the lower the bank's credit risk. Conversely, if the differential becomes less than zero, then the leverage effect will act to the detriment of the enterprise, that is, there will be a deduction from the return on equity, and investors will not be willing to buy shares of the issuing enterprise with a negative differential.

Thus, an enterprise's debt to a commercial bank is neither good nor evil, but it is its financial risk. By attracting borrowed funds, an enterprise can more successfully fulfill its tasks if it invests them in highly profitable assets or real investment projects with a quick return on investment.

The main task for a financial manager is not to eliminate all risks, but to take reasonable, pre-calculated risks, within the positive value of the differential. This rule is also important for the bank, because a borrower with a negative differential is distrustful.

Financial leverage is a mechanism that a financial manager can master only if he has accurate information about the profitability of the company's assets. Otherwise, it is advisable for him to treat the debt ratio very carefully, weighing the consequences of new borrowings in the loan capital market.

The second way to calculate the effect of financial leverage can be viewed as a percentage (index) change in net profit per ordinary share, and the fluctuation in gross profit caused by this percentage change. In other words, the effect of financial leverage is determined by the following formula:

leverage strength = percentage change in net income per ordinary share: percentage change in gross income per ordinary share.

The smaller the impact of financial leverage, the lower the financial risk associated with this enterprise. If borrowed funds are not involved in circulation, then the force of the financial leverage is equal to 1.

The greater the force of financial leverage, the higher the company's level of financial risk in this case:

for a commercial bank, the risk of non-repayment of the loan and interest on it increases;

for the investor, the risk of reducing dividends on the shares of the issuing enterprise with a high level of financial risk that he owns increases.

The second method of measuring the effect of financial leverage makes it possible to perform an associated calculation of the strength of the impact of financial leverage and establish the total (general) risk associated with the enterprise.

In terms of inflation if the debt and interest on it are not indexed, the effect of financial leverage increases, since debt servicing and the debt itself are paid for with already depreciated money. It follows that in an inflationary environment, even with a negative value of the differential of financial leverage, the effect of the latter can be positive due to non-indexation of debt obligations, which creates additional income from the use of borrowed funds and increases the amount of equity capital.