Financial leverage effect This is an indicator that reflects the change in the profitability of equity, obtained through the use of borrowed funds, and is calculated using the following formula:

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

D - borrowed capital;
E - equity.

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

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

By the way, the widespread theory says that the US mortgage crisis was a manifestation of the negative effect of financial leverage. When the non-standard mortgage lending program was launched, loan rates were low, while real estate prices rose. Low-income strata of the population were involved in financial speculation, since almost the only way to repay the loan for them was the sale of more expensive housing. When house prices crawled down, and interest rates on loans increased due to the increasing risks (the lever began to generate not profit, but losses), the pyramid collapsed.

The constituents leverage effect are presented in the figure below:

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

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

Dif \u003d ROA - r

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

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

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

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

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

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

The effect of financial leverage contributes to the formation of a rational structure of sources of funds of the enterprise 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 disturbed.

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

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

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

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

if ROA\u003e i, then ROE\u003e ROA and ΔROE \u003d (ROA - i) * D / E

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

The level of associated risk characterizes the operational and financial leverage. Operating and financial leverage, along with the positive effect of increased profitability on assets and equity as a result of increased sales and borrowed funds, also reflects the risk of a decrease in profitability and incurring losses.

Financial leverage effect

The financial risk of an enterprise is primarily due to the structure of the sources of its property, i.e. the ratio of equity and debt capital raised to finance its activities. Almost all funds are attracted by the enterprise on a reimbursable basis, however, the obligations for their various sources are not the same: if the company fails to fulfill its obligations to external investors, they may initiate the bankruptcy procedure. Therefore, the essence of financial risk is that a high proportion of borrowed capital increases the risk of the company's inability to pay off its obligations and, as a consequence, its possible bankruptcy. On the other hand, attracting borrowed funds allows the company to receive additional profit on equity capital.

To characterize the relationship between the profit of the enterprise, the cost of resources spent on its receipt and the costs incurred in connection with the attraction and maintenance of the formed structure of sources of financing for the enterprise, a special economic category is used - leverage (leverage).

Leverage (leverage - the action of a lever, force, means to an end) is a long-term acting factor, the value of which can be controlled; even a small change in it can lead to a significant change in the resulting performance indicators of the company.

Financial leverage characterizes the use of borrowed funds by the enterprise, which affects the change in the return on equity ratio; arises with the appearance of borrowed funds in the composition of the used by the enterprise and is closely related to the category of financial risk of the company.

There are various approaches to determining financial leverage.

1. Actually the ratio of financial leverage (2.6) - characterizes the ratio of borrowed and own funds of the enterprise, the higher its value, the more borrowed capital falls on each ruble of its own, and the higher the financial risk of the company.

2. The European approach considers financial leverage as an indicator reflecting the level of additionally generated profit on equity when the company uses borrowed funds. It is called the leverage effect and is calculated using the following formula:

where EFR 1 is the effect of financial leverage, calculated in the first way (European approach);

С n.p - income tax rate, expressed as a decimal fraction;

ER A - economic profitability of assets, calculated by the formula (2.14) and expressed in%;

SP - the average interest rate on loans, expressed in%;

ZK cf - the average amount of borrowed capital used by the enterprise;

SK cf - the average amount of the company's equity capital.

Numerically, EFR 1 is equal to the increase in the net return on equity in the transition from the debt-free financing option to the existing capital structure for the period under review. Its positive value indicates that the attraction of debt capital allows the company to increase the return on equity. At the same time, its negative or very large value indicates a high level of financial risk.

The formula for the effect of financial leverage (3.12) has three components.

· Tax adjuster of financial leverage (1 - C n.p) - characterizes the extent to which the effect of financial leverage manifests itself in connection with different levels of taxation of profits. Its value practically does not depend on the activities of the enterprise, since the income tax rate is established by law. At the same time, in the process of managing financial leverage, a differentiated tax corrector can be used in the following cases:

If differentiated rates of profit taxation are established for various types of activities of the enterprise;

If for certain types of activities the company uses tax benefits on profits;

If individual subsidiaries of the enterprise operate in free economic zones, where there is a preferential tax treatment of profits;

If individual subsidiaries of the enterprise operate in countries with a lower level of income taxation.

In these cases, by influencing the sectoral or regional structure of production (and, accordingly, the composition of profit by the level of its taxation), it is possible, by lowering the average rate of taxation of profit, to increase the effect of the tax corrector on the effect of financial leverage.

· The differential of financial leverage (ER A - JV) - characterizes the difference between the gross return on assets and the average interest on a loan, is the main condition that forms its positive effect. If the additional profit received by the enterprise when using borrowed funds exceeds the financial costs that it incurs when using borrowed capital, then the value of this indicator is positive. The higher the positive value of the financial leverage differential, the higher its effect will be.

Due to the high dynamics of this indicator, it requires constant monitoring in the process of managing the effect of financial leverage. This dynamism is due to a number of factors.

During a period of deterioration in the financial market (with a reduction in the volume of capital supply), the cost of borrowed funds may rise sharply, exceeding the level of gross profit generated by the assets of the enterprise;

A decrease in the financial stability of an enterprise with an increase in the share of borrowed capital used leads to an increase in the risk of bankruptcy, which forces lenders to increase the level of interest rates for loans, taking into account the risk premium; at a certain level of the total interest rate for a loan, the differential of financial leverage can become zero (when the use of borrowed capital does not provide an increase in the return on equity) or negative (when the return on equity decreases, since part of the net profit generated by equity capital will be spent on servicing the used borrowed capital at high interest rates);

During a period of deterioration in the commodity market, the volume of sales of products decreases, and, accordingly, the size of the gross profit of the enterprise from operating activities; in these conditions, a negative value of the differential of financial leverage can be formed even at constant interest rates for a loan due to a decrease in the coefficient of economic profitability of assets.

The formation of a negative value of the differential of financial leverage for any of the above reasons leads to a decrease in the return on equity ratio. In this case, the use of borrowed capital by the enterprise gives a negative effect, which means it is unprofitable.

· The ratio of financial leverage or its leverage (ZK avg / SK avg) - characterizes the amount of borrowed capital used by the enterprise, per unit of equity capital, is the factor that enhances the positive or negative effect obtained due to the corresponding value of its differential. With a positive value of the differential, any increase in the ratio of financial leverage will cause an even greater increase in the return on equity ratio, and with a negative value of the differential, an even greater rate of its decline. In other words, an increase in the financial leverage ratio causes an even greater increase in its effect (positive or negative, depending on the positive or negative value of the differential).

With a constant differential, the leverage ratio is the main generator of both an increase in profit on equity and the financial risk of losing this profit.

Formula (3.12) is classic and does not take into account the specifics of Russian taxation. As noted above, according to the current Tax Code, financial costs are divided into two categories: attributable to costs and financial results. In this regard, the formula for the effect of financial leverage adapted to Russian tax conditions is as follows

where SP c is the rate of interest on borrowed capital attributed to the cost of production;

SP n - the rate of interest on borrowed capital attributable to financial results (profit).

3. The American approach to assessing the effect of financial leverage (also called the level of financial leverage) is to highlight its impact on the amount of net profit, namely, how sensitive the net profit is to changes in operating profit (NREI). The result is defined as the ratio of the rate of change in net profit in the current period in relation to the previous one, expressed as a percentage, to the same rate of change in operating profit:

, (3.14)

where EFR 2 is the effect of financial leverage, calculated in the second way (American approach);

CP (%) \u003d (CP 1 - CP 0) / CP 0 × 100% - the rate of change in net profit in the current period relative to the previous one,%;

NREI (%) \u003d (NREI 1 - NREI 0) / NREI 0 × 100% - the rate of change in operating profit in the current period relative to the previous one,%.

The value of EGF 2 shows the percentage of the change in net profit when operating profit changes by 1%. The greater the amount of financial costs incurred by the company in terms of borrowed capital, the more the difference between net and operating profit will be, the more significant will be the change in net profit with a change in operating, and therefore, the higher will be the effect of financial leverage. In this case, it is a measure of financial risk, its high value indicates significant financial costs of the firm.

Transformation of formula (3.14) gives the classical formula for EGF 2:

, (3.15)

where BP is the balance sheet profit (profit before tax) of the enterprise.

Formula (3.15) is also not quite adapted to Russian financial management. The modified formula for the leverage effect is as follows

. (3.16)

Knowledge of the mechanism of influence of financial leverage on the level of profitability of equity capital and the level of financial risk allows you to purposefully manage both the value and the structure of the company's capital.

test questions

1. What is the financial risk of an enterprise? What types of risks exist, in connection with what do they arise?

2. What is the main goal and objectives of financial risk management?

3. Describe the procedure for managing the financial risks of the enterprise.

4. What are the main methods used to assess financial risks? Is there a universal one among them? Justify your answer.

5. What are the ways to neutralize financial risks? What are the advantages and disadvantages of external and internal mechanisms for their neutralization?

6. List the main ways of external financing of the enterprise. What are the benefits of each of them?

7. What are the risks associated with different external funding sources?

8. How and for what purpose are the operating profit threshold and financial tipping point calculated?

9. Give a definition of the concept of leverage (leverage). In this connection, the concept of financial leverage arises in the course of the company's activity?

10. What are the approaches to determining the numerical value of financial leverage?

The ratio of financial leverage (financial leverage) gives an idea of \u200b\u200bthe real ratio of equity and borrowed funds in the company. Based on the data on the financial leverage ratio, one can judge the stability of an economic entity, the level of its profitability.

What does financial leverage mean?

The financial leverage ratio is often called financial leverage, which is able to influence the level of an organization's profit by changing the ratio of equity and borrowed funds. It is used in the process of analyzing the subject of economic relations to determine the level of its financial stability in the long term.

The values \u200b\u200bof the leverage ratio help company analysts to identify additional potential for profitability growth, assess the degree of possible risks and determine the dependence of the profit level on external and internal factors. With the help of financial leverage, it is possible to influence the net profit of the organization by managing financial liabilities, as well as a clear idea of \u200b\u200bthe advisability of using credit funds.

Types of financial leverage

According to the efficiency of use, there are several types of financial leverage:

1. Positive. It is formed when the benefit from attracting borrowed funds exceeds the payment (interest) for using a loan.
2. Negative. It is typical for a situation when the assets acquired through obtaining a loan do not pay off, and there is either no profit or below the listed percentages.
3. Neutral. Financial leverage, in which income from investments is equal to the cost of obtaining borrowed funds.

Financial leverage formulas

The financial leverage ratio is the ratio of borrowed and own funds. The calculation formula is as follows:

FL \u003d ZK / SK,

where: FL - financial leverage ratio;

ЗК - borrowed capital (long-term and short-term);

SK - equity capital.

This formula also reflects the financial risks of the enterprise. The optimal value of the coefficient ranges from 0.5 to 0.8. With such indicators, it is possible to maximize profits with minimal risks.

For some organizations (trade, banking), a higher value is acceptable, provided that they have a guaranteed cash flow.

Most often, when determining the level of the coefficient value, not the book (accounting) value of equity capital is used, but the market value. The indicators obtained in this case will most accurately reflect the current situation.

A more detailed version of the formula for the leverage ratio is as follows:

FL \u003d (ZK / SA) / (IR / SA) / (OA / IR) / (OK / OA) × (OK / SK),

where: ЗК - borrowed capital;

CA - the amount of assets;

IC - invested capital;

ОА - current assets;

OK - working capital;

SK - equity capital.

The ratio of indicators presented in brackets has the following characteristics:

• (ЗК / CA) - financial dependence ratio. The lower the ratio of borrowed capital to total assets, the more financially stable the company is.
• (IC / CA) is a coefficient that determines financial independence of a long-term nature. The higher the score, the more resilient the organization is.
• (OA / IC) - coefficient of maneuverability of the IC. Its lower value, which determines financial stability, is preferable.
• (OK / OA) - the ratio of working capital. High rates characterize the high reliability of the company.
• (OK / SK) - the coefficient of maneuverability of the SK. Financial stability increases with decreasing ratio.

Example 1

The enterprise at the beginning of the year has the following indicators:

• ЗК - 101 million rubles;
• CA - 265 million rubles;
• OK - 199 million rubles;
• OA - 215 million rubles;
• SK - 115 million rubles;
• IR - 118 million rubles.

Let's calculate the financial leverage ratio:

FL \u003d (101/265) / (118/265) / (215/118) / (199/215) × (199/115) \u003d 0.878.

Or FL \u003d ZK / SK \u003d 101/115 \u003d 0.878.

The conditions that characterize the profitability of the IC (equity capital) are greatly influenced by the amount of borrowed funds. The value for the profitability of the IC (equity capital) is determined by the formula:

RSK \u003d PE / SK,

PE - net profit;

For a detailed analysis of the financial leverage ratio and the reasons for its changes, one should consider all 5 indicators included in the considered formula for its calculation. As a result, it will be clear the sources due to which the indicator of financial leverage increased or decreased.

Financial leverage effect

Comparison of indicators of the ratio of financial leverage and profitability as a result of the use of equity capital (equity) is called the effect of financial leverage. As a result, you can get an idea of \u200b\u200bhow the profitability of the IC depends on the level of borrowed funds. The difference between the cost of return on assets and the level of inflow of funds from the outside (that is, borrowed) is determined.

• VD - gross income or profit before taxation and transfer of interest;
• PSP - profit before taxes, reduced by the amount of interest on loans.

The VD indicator is calculated as follows:

VD \u003d C × O - I × O - PR,

where: C - the average price of products;

О is the volume of the issue;

And - costs per 1 unit of goods;

PR - fixed production costs.

The effect of financial leverage (EF) is considered as the ratio of profit indicators before and after interest payment, that is:

EFL \u003d VD / PSP.

In more detail, the EFL is calculated based on the following values:

EFL \u003d (RA - CZK) × (1 - SNP / 100) × ZK / SK,

where: RA - return on assets (measured as a percentage excluding taxes and interest on the loan payable);

CPC - the cost of borrowed funds, expressed as a percentage;

SNP is the current rate of income tax;

ЗК - borrowed capital;

SK - equity capital.

Return on assets (RA) as a percentage, in turn, is equal to:

RA \u003d VD / (SK + ZK) × 100%.

Example 2

Let's calculate the effect of financial leverage using the following data:

• VD \u003d 202 million rubles;
• SK \u003d 122 million rubles;
• ZK \u003d 94 million rubles;
• CPC \u003d 14%;
• SNP \u003d 20%.

Using the formula EFL \u003d EFL \u003d (RA - CZK)× (1 - SNP / 100)× ZK / SK, we get the following result:

EFL \u003d (202 / (122 + 94)× 100) - 14,00)% × (1 - 20 / 100) × 94 / 122= (93,52% - 14,00%) × (1 - 0,2) × 94 / 122 =79,52% × 0,8 × 94 / 122 = 49,01%.

Example 3

If, under the same conditions, there is an increase in borrowed funds by 20% (up to 112.8 million rubles), then the EFL indicator will be equal to:

EFL \u003d (202 / (122 + 112.8)× 100 - 14,00)% × (1 - 20 / 100) × 112,8 / 122 = (86,03% - 14,00%) × 0,8 × 112,8 / 122 = 72,03% × 0,8 × 112,8 / 122 = 53,28%.

Thus, by increasing the level of borrowed funds, it is possible to achieve a higher EFL indicator, that is, to increase the return on equity by attracting borrowed funds. At the same time, each company conducts its own assessment of financial risks associated with difficulties in repaying loan obligations.

The factors characterizing the return on equity are also influenced by the factors of attracting borrowed funds. The formula for determining the return on equity will be:

RSK \u003d PE / SK,

where: RSK - return on equity;

PE - net profit;

SK - the amount of equity capital.

Example 4

The balance sheet profit of the organization amounted to 18 million rubles. The current income tax rate is 20%, the size of the IC is 22 million rubles, the LC (attracted) is 15 million rubles, the amount of interest on the loan is 14% (2.1 million rubles). What is the profitability of an IC with and without borrowed funds?

Solution 1 ... Net profit (NP) is equal to the sum of the balance sheet profit minus the cost of borrowed funds (interest equal to 2.1 million rubles) and income tax on the remaining amount: (18 - 2.1)× 20% \u003d 3.18 million rubles.

PE \u003d 18 - 2.1 - 3.18 \u003d 12.72 million rubles.

The profitability of the UK in this case will have the following value: 12.72 / 22× 100% = 57,8%.

Solution 2. The same indicator without attracting funds from outside will be equal to 14.4 / 22 \u003d 65.5%, where:

PP \u003d 18 - (18× 0.2) \u003d 14.4 million rubles.

Outcomes

By analyzing the data of the indicators of the financial leverage ratio and the effect of financial leverage, it is possible to manage the enterprise more efficiently, based on attracting a sufficient amount of borrowed funds, without going beyond the contingent financial risks. The formulas and examples given in our article will help you calculate the indicators.

Economic analysis Litvinyuk Anna Sergeevna

30. Leverage (financial leverage). Financial leverage effect

Financial leverage ("financial leverage") is a financial mechanism for managing the return on equity by optimizing the ratio of equity and borrowed funds used. Thus, the financial leverage allows you to influence profit by optimizing the capital structure.

The effect of financial leverage is an indicator that reflects the increment in the profitability of equity obtained through the use of a loan, despite the fact that the latter is paid. It is calculated using the following formula:

EFL \u003d (1? NP)? (P A?% Avg.) ZK / SK,

where EFL is the effect of financial leverage, which consists in an increase in the return on equity ratio,%; ПН - income tax rate, expressed as a decimal fraction; Р А - coefficient of gross profitability of an asset (the ratio of gross profit to the average value of assets),%; % wed - the average amount of interest on a loan paid by the company for the use of borrowed capital,%; 3К - the average amount of borrowed capital used by the enterprise; SK is the average amount of the company's equity capital.

The above formula for calculating the effect of financial leverage allows us to distinguish three main components in it:

1. Tax corrector of financial leverage (1-NP), which shows the extent to which the effect of financial leverage manifests itself in connection with different levels of taxation of profits.

2. Differential financial leverage (R A?% Avg.), Which reflects the difference between the gross return on assets and the average interest on a loan.

3. Leverage of financial leverage ZK / SK, which characterizes the amount of borrowed capital used by the company, per unit of equity capital.

The tax corrector of financial leverage practically does not depend on the activities of the enterprise, since the income tax rate is established by law. In the process of managing financial leverage, a differential tax corrector can be used in the following cases:

Differentiation of the rate of taxation of profits or the availability of tax incentives for various types of activities of the enterprise;

Carrying out activities of subsidiaries of the enterprise in offshore zones or countries with a different tax climate. The financial leverage differential is the main

a condition that forms a positive effect of financial leverage, if the level of gross profit generated by the assets of the enterprise exceeds the average rate of interest for the loan used. The higher the positive value of the financial leverage differential, the higher, other things being equal, will be its effect.

Financial leverage is the leverage that has a positive or negative effect on the differential. With a positive value of the differential, any increase in the financial leverage ratio will cause an even greater increase in the return on equity ratio, and with a negative value of the differential, an increase in the financial leverage ratio will lead to an even greater rate of decrease in the return on equity ratio. Thus, with a constant differential, the leverage of financial leverage is the main generator of both an increase in the amount and level of profit on equity, and the financial risk of losing this profit. Similarly, with a constant leverage of financial leverage, the positive or negative dynamics of its differential generates both an increase in the amount and level of profit on equity, and the financial risk of its loss.

Knowledge of the mechanism of influence of financial capital on the level of profitability of equity capital and the level of financial risk allows you to purposefully manage both the value and the structure of the enterprise's capital.

The quantitative value of the influence of factors on the change in the resulting indicator is found by applying one of the special techniques of economic analysis.

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From the book Real Estate Investments the author Kiyosaki Robert Tohru

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From the book Comprehensive Economic Analysis of an Enterprise. Short course the author Team of authors

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From the book How to Make Millions on Ideas by Kennedy Dan

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Leverage effect \u003d speed Leverage effect is equivalent to speed. If you want to get rich without the power of leverage and significant power, you cannot do it. The enrichment "lever mechanism" consists of three parts. The first part is your goal (dream) that you want to achieve.

From the book Sales Department Management the author Petrov Konstantin Nikolaevich

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Financial Leverage The third leverage on ROE is financial. The company increases this indicator by increasing the ratio of borrowed capital to equity to finance the business. In contrast to the return on sales and the asset turnover ratio,

Leverage (from English leverage) has the following meanings:

the proportion, the ratio of capital investments in securities with a fixed income, for example, in bonds, preferred shares, and investments in securities with non-fixed income, for example, in ordinary shares;

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

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

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

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

Financial leverage effect- this is an increment to the profitability of own funds, obtained through the use of a loan, despite the fact that the latter is paid. - Financial management: theory and practice. Textbook / Under. ed. E.S. Stoyanova. - M .: Publishing house "Perspective", 1998. - p. 150.

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

Let's consider an example of the effect of financial leverage.

Background information:

In 1999, an American stationery company called Red Tape was successful in the Eastern European market. Her self-sharpening pencils were especially popular. The Eastern European market was not yet saturated with them and, striving to expand its influence in this sector as soon as possible before the arrival of competitors, the Red Tap company, represented by the administration, planned at the beginning of 2000 to purchase additional equipment for the production of self-sharpening pencils, which would increase production capacity twice. This required an additional $ 1 million. Over the sources of funding, heated debates erupted between the president of the company, Walter, and the chairman of the board of directors, Stevens. The essence of the disagreement was as follows:

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

Stevens proposed to organize the issue of corporate bonds in the amount of $ 1 million in the amount of 10 thousand pieces with a par value of $ 100, since the amount of the authorized capital does not change, which is quite satisfactory for Stevens. This proposal angered Walter, because, in his opinion, the issue of bonds, increasing the level of the company's debt as a whole, worsens the indicator of financial stability. Even Stevens' proposal to lower the dividend rate to the level of the interest rate on bonds (up to 10 percent per annum) did not affect the opinion of Walter, who believes that this does not bring any benefit to the company.

It is necessary, by taking the position of Chairman of the Board of Directors of Stevens, to prove that the issue increases the sources of financing for the Red Tap company in comparison with 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 total profitability of production (before interest and tax) is 20 percent per annum, are presented in table 7.

Table 7. Financial results of the company

Indicators		Stevens variant
Total capital Authorized capital Bond loan	2000 thousand dollars 2000 thousand dollars	2000 thousand dollars 1000 thousand dollars 1000 thousand dollars
Total profit (before interest and tax)	400 thousand dollars	400 thousand dollars
Bonds coupon payments		100 thousand dollars
Profit before tax	400 thousand dollars	400 thousand dollars
Income tax	200 thousand dollars	150 thousand dollars
Net profit	200 thousand dollars	150 thousand dollars
Dividend payments	200 thousand dollars	100 thousand dollars
Undestributed profits		50 thousand dollars
Earnings per share
Stock returns

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

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 (AP). In other words, the company must develop such an economic profitability (ER) that there are enough funds, at least to pay interest on a 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 be made from two main sources. First, they can be written off to the cost of products manufactured by the enterprise, within the rate of the Central Bank plus 3 percent. This part of the financial costs is not affected by taxes. The second source is profits after taxes. In this case, when analyzing, to obtain the actual financial costs, the corresponding interest amounts must be increased by the amounts transferred to the state budget in the form of tax.

For example: the amount of interest paid from 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 from the profit remaining at the disposal of the enterprise - 135 thousand rubles.

In addition to formula (62), you can calculate the average interest rate not by the arithmetic mean, but by the weighted average cost of various loans and borrowings. It is also possible to classify as borrowed funds the money received by the company 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 akin to borrowing and, in addition, upon liquidation of an enterprise, owners of preferred shares have almost equal rights with creditors to what is due to them. 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, the standard for attributing interest to the prime cost was at the end of 1998 (60% + 3%) \u003d 63%, and the loan was provided to the enterprise at 70% per annum, then, taking into account tax savings, such a loan cost the borrower in (1 - 0, 35) 63% + (1 + 0.35) (70% - 63%) \u003d 50.40%.

To calculate the effect of financial leverage, let us 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). Including tax, the differential is equal to or approximately 2/3 (ER- SP).

The second component is lever arm- characterizes the strength of the lever. This is the ratio between borrowed and own funds. 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 undertaking A is 20 percent.

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

The first way to calculate the level of leverage:

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

When using borrowed funds, you should remember two important rules:

If the new borrowing brings the enterprise 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 the leverage is increased, the banker is inclined to compensate for the increase in his risk by increasing the price of his "commodity" - credit.

The lender'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 irrepressible increase in borrowing may worsen.

The above enterprise A, with a leverage effect of 4 percent and a differential of 2 percent, with a credit rise of only 1 percentage point, will have to adjust the lever arm 6 to maintain the same leverage effect.

EGF \u003d 2/3 (20% - 19%) 6 \u003d 4%.

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

Further, a moment may come when the differential becomes less than zero. The leverage effect will then act only to the detriment of the enterprise if, for example, with a nine-fold ratio of borrowed and own funds, an average rate of 22 percent on the loan has to be paid, then the leverage effect and profitability of enterprise A's own funds will be:

To identify the optimal relationship between the return on equity, the economic return on assets, the average interest rate and the leverage, let us build graphs (Fig. 6).

It can be seen from these graphs that the smaller the gap between ER and the average interest rate (AP), the larger the share has to be allocated to borrowed funds to raise the RCC, but this is unsafe when the differential is reduced.

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

lever arm 0.75 at ER \u003d 3SP

lever arm 1.0 at ER \u003d 2SP

lever arm 1.5 at ER \u003d 1.5СП

Thus, ER \u003d 3 SRSP

ER \u003d 2 SRSP

ER \u003d 1.5 SRSP

The second concept of the leverage effect

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

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

With the help of this formula, they answer the question, by what percentage will the net profit for each ordinary share change if the net result of the operation of investments changes by one percent.

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

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

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

2. The risk of falling dividend and share price for the investor increases.