To calculate the effect of financial leverage (EFR), it is necessary to calculate the economic profitability (ER) and the average calculated interest rate (ARR).
EFR = 2/3 (ER - SRSP) * ЗС / SS
Where ER = Net result of operating the investment / (Own funds + Borrowed funds),
PSI = Finance Interest Cost / Borrowed * 100%
This formula can be presented in a more extended version.
Service purpose... Using the online calculator, a step-by-step analysis of the company's activities is carried out:
- Calculation of the effect of financial leverage.
- Analysis of the sensitivity of profit to changes in the analyzed factor.
- Determination of the compensating change in the volume of sales when the analyzed factor changes.
Instruction. Fill in the table, click Next. The solution report will be saved in MS Word format.
Indicators such as Equity (CC), Borrowed funds (LC), Retained earnings of previous years, Authorized capital, Current Assets, Current Liabilities and Profitability of Sales can be determined from the balance sheet data (found using a calculator).
Classification of the effect of financial leverage
An example. Table 1 - Initial data
| Indicators | Meaning |
| 1. Proceeds from sales thousand rubles. | 12231.8 |
| 2. Variable costs, thousand rubles. | 10970.5 |
| 3. Fixed costs thousand rubles. | 687.6 |
| 4. Own funds (SS) thousand rubles. | 1130.4 |
| 5. Borrowed funds (AP) thousand rubles. | 180 |
| 6. Financial costs of borrowed funds (FI) thousand rubles. | 32.4 |
Determine the financial performance of the enterprise
Table 1 - Indicators of the enterprise
1. Calculation of the effect of financial leverage
To calculate the effect of financial leverage (EFR), it is necessary to calculate the economic profitability (ER) and the average calculated interest rate (ARI).
ER = NREI / Assets * 100 = 606.1 / (1130.4 + 180) * 100 = 46.25%
SRSP = FI / ЗC * 100 = 32.4 / 180 * 100 = 18%
EGF = 2/3 (ER - SRSP) * ЗС / SS = 2/3 (46.25% - 18%) * 180 / 1130.4 = 3.0%
RSS = 2/3 * ER + EGF = 2/3 * 46.25 + 3.0 = 33.84%
The essence of the effect of financial leverage: the effect of financial leverage shows the increment to the profitability of equity obtained as a result of the use of borrowed capital. In our case, it was 3.0%.
The effect of financial leverage can also be used to assess the creditworthiness of an enterprise.
Since the leverage is less than 1 (0.159), this company can be regarded as creditworthy. The meaning of the leverage effect: the company can apply for an additional loan.
Using the graphical method, we will determine the safe amount of borrowed funds. Typical differential curves are shown in Fig. 1.
Rice. 1. Curves of differentials
Let's define the position of our enterprise on the graph.
ER / SRSP = 46.25 / 18 = 2.57
Whence ER = 2.57SRSP
With additional borrowing, it is necessary that the enterprise does not fall below the main curve (the enterprise is between ER = 3SRSP and ER = 2SRSP). Therefore, at the level of tax neutralization at the point EFR / RCC = 1/3, the allowable leverage of the financial leverage ZS / SS is 1.0.
Thus, the loan can be increased by 950.4 thousand rubles. and reach 1130.4 thousand rubles.
Let's define the upper limit of the price of borrowed capital.
ER = 2SRSP
From where SRSP = 46.25% / 2 = 23.13%
CPCP = FI / ЗС
Where FI = SRSP * ЗС = 23.13% * 1130.4 = 261.422 thousand rubles.
Thus, this enterprise without losing financial stability, you can take an additional amount of borrowed funds by 950.4 thousand rubles. Additional borrowing will cost the company 219.795 thousand rubles, if the average interest rate on a loan does not exceed 23.13%.
Let's calculate critical value the net result of the exploitation of investments, i.e. such a value at which the effect of financial leverage is zero, and therefore, the return on equity is the same for options, both with the involvement of borrowed funds and using only own funds.
NREI critical = 1310.4 * 18 = 235.872 thousand rubles.
In our case, the threshold value has been passed, which means that it is profitable for the enterprise to attract borrowed funds.
Let us consider the financial leverage of an enterprise, the economic sense, the formula for calculating the effect of financial leverage and an example of its assessment for the company JSC RusHydro.
Financial leverage enterprises (analogue: leverage, leverage, financial leverage, leverage) - shows how the use of the company's debt capital affects the amount of net profit. Financial leverage is one of the key concepts in the financial and investment analysis of an enterprise. In physics, using a lever allows you to lift more weight with less effort. There is a similar principle of operation in economics for financial leverage, which allows, with less effort, to increase the amount of profit.
Purpose of using financial leverage is to increase the profit of the enterprise by changing the capital structure: the share of own and borrowed funds. It should be noted that an increase in the share of borrowed capital (short-term and long-term liabilities) of an enterprise leads to a decrease in its financial independence. But at the same time, with an increase in the financial risk of an enterprise, the possibility of obtaining greater profits also increases.
Financial leverage. Economic meaning
The effect of financial leverage is explained by the fact that attracting additional Money allows to increase the efficiency of production and economic activities of the enterprise. After all, the attracted capital can be used to create new assets that will increase both cash flow and the net profit of the enterprise. Additional cash flow leads to an increase in the value of the enterprise for investors and shareholders, which is one of the strategic objectives for the owners of the company.
Financial leverage effect. Calculation formula
Financial leverage effect is the product of the differential (with tax corrector) by the lever arm. The figure below shows a diagram of the key links in the formation of the effect of financial leverage.
If we describe the three indicators included in the formula, then it will look like this:
T is the interest rate of income tax;
ROA is the return on assets of the enterprise;
r is the interest rate on the attracted (borrowed) capital;
D - borrowed capital of the enterprise;
E - equity capital of the enterprise.
So, let's take a closer look at each of the elements of the leverage effect.
Tax corrector
The tax adjuster shows how the change in the income tax rate affects the effect of financial leverage. Everybody pays income tax legal entities RF (LLC, OJSC, CJSC, etc.), and its rate may vary depending on the type of activity of the organization. So, for example, for small enterprises employed in the housing and communal sector, the final income tax rate will be 15.5%, while the unadjusted income tax rate is 20%. The minimum income tax rate by law cannot be lower than 13.5%.
Differential of financial leverage
Leverage differential (Dif) is the difference between the return on assets and the leverage rate. In order for the effect of financial leverage to be positive, it is necessary that profitability equity capital was higher than the interest on loans and borrowings. With negative financial leverage, the company begins to suffer losses, because it cannot provide production efficiency higher than the payment for borrowed capital.
Leverage Ratio (analogue: leverage) shows what proportion in general structure the capital of the enterprise borrowed borrowed funds (loans, loans and other obligations), and determines the strength of the influence of borrowed capital on the effect of financial leverage.
Optimal leverage for leverage
Based on empirical data, the optimal leverage (the ratio of debt and equity capital) for the company was calculated, which is in the range from 0.5 to 0.7. This suggests that the share of borrowed funds in the overall structure of the enterprise ranges from 50% to 70%. With an increase in the share of borrowed capital, financial risks increase: the possibility of loss of financial independence, solvency and the risk of bankruptcy. When the amount of the borrowed capital is less than 50%, the company misses the opportunity to increase profits. The optimal size of the effect of financial leverage is considered to be a value equal to 30-50% of the return on assets (ROA).
An example of calculating the effect of financial leverage for JSC RusHydro on the balance sheet
One of the formulas for calculating the effect of financial leverage is the excess of the return on equity ( ROA, Return on Assets) over the return on equity ( ROE, Return on Equity). Return on equity (ROA) shows the profitability of the enterprise's use of both equity and borrowed capital, while ROE reflects only the efficiency of equity. The calculation formula will look like this:
where:
DFL - financial leverage effect;
ROA is the return on equity (assets) of the enterprise;
ROE - return on equity
Let's calculate the effect of financial leverage for the enterprise of JSC RusHydro according to the balance sheet. To do this, we will calculate the profitability coefficients, the formulas of which are presented below:
Calculation of the return on assets ratio (ROA) by balance
Calculation of the return on equity ratio (ROE) by balance
The balance sheet of JSC RusHydro was taken from the official website of the enterprise.
Report on financial results presented below:
Calculation of the effect of financial leverage for JSC RusHydro
Let us calculate each of the profitability ratios and evaluate the effect of financial leverage for JSC RusHydro in 2013.
ROA = 35321/816206 = 4.3%
ROE = 35321/624343 = 5.6%
Effect of financial leverage (DFL)= ROE - ROA = 5.6 - 4.3 = 1.3%
The effect shows that the use of borrowed capital by JSC RusHydro made it possible to increase the profitability of its activities by 1.3%. The size of the effect of financial leverage on the return on equity is about ~ 30%, which is the optimal ratio and indicates effective management of borrowed capital.
Summary
The effect of financial leverage shows the effectiveness of the use of borrowed capital by an enterprise to increase its efficiency and profitability. Increasing profitability allows you to reinvest funds in the development of production, technology, human resources and innovation potential. All this helps to increase the competitiveness of the enterprise. Illiterate management of equity capital can lead to rapid growth insolvency and the risk of bankruptcy.
Any company strives to increase its market share. In the process of formation and development, the company creates and increases its own capital. At the same time, it is very often necessary to attract external capital to jump in growth or launch new directions. For a modern economy with a well-developed banking sector and exchange structures, it is not difficult to gain access to debt capital.
Capital balance theory
When attracting borrowed funds, it is important to maintain a balance between the obligations undertaken to pay and the goals set. Violating it, you can get a significant decrease in the rate of development and deterioration of all indicators.
According to the Modigliani-Miller theory, the presence of a certain percentage of borrowed capital in the structure total capital which the company has at its disposal is beneficial for the current and future development of the company. Borrowed funds at an affordable service price allow them to be directed to promising directions, in this case, the effect of the monetary multiplier will work, when one nested unit will give an increase in an additional unit.
But in the presence of a high share of borrowed funds, the company may not fulfill its internal and external obligations by increasing the amount of loan servicing.
Thus, the main task of a company that attracts third-party capital is to calculate the optimal leverage ratio and create an equilibrium in the overall capital structure. It is very important.
Financial leverage (leverage), definition
Leverage is the existing ratio between two capital in a company: equity and borrowed. For a better understanding, you can formulate the definition in a different way. The financial leverage ratio is an indicator of the risk that a company assumes when creating a certain structure of funding sources, that is, using both its own and borrowed funds as them.
For understanding: the word "leverage" is English, which means "leverage" in translation, therefore, the leverage of financial leverage is often called "financial leverage". It is important to understand this and not think that these words are different.
Leverage Components
The leverage ratio takes into account several components that will affect its indicator and effects. Among them are:
- Taxes, namely the tax burden borne by the company in the implementation of its activities. Tax rates are set by the state, so a company on this issue can regulate the level of tax deductions only by changing the selected tax regimes.
- Financial leverage indicator. This is the ratio of borrowed funds to equity. This indicator alone can give an initial idea of the price of the attracted capital.
- Financial leverage differential. It is also a matching indicator, which is based on the difference in the profitability of assets and the interest that is paid on borrowed loans.
Financial Leverage Formula
You can calculate the ratio of financial leverage, the formula of which is quite simple, as follows.
Leverage = Equity / Equity
At first glance, everything is clear and simple. The formula shows that the leverage ratio is the ratio of all borrowed funds to equity capital.
Leverage, effects
Leverage (financial) is associated with borrowed funds, which are aimed at the development of the company, and profitability. Having determined the capital structure and having obtained the ratio, that is, by calculating the coefficient of financial leverage, the formula for the balance of which is presented, it is possible to assess the efficiency of capital (that is, its profitability).
The leverage effect gives an understanding of how much the efficiency of equity capital will change due to the fact that external capital has been attracted into the firm's turnover. To calculate the effect, there is an additional formula that takes into account the indicator calculated above.
Distinguish between positive and negative effects of financial leverage.
The first is when the difference between the return on total capital after all taxes have been paid exceeds the interest rate for the loan provided. If the effect is greater than zero, that is, positive, then it is profitable to increase the leverage and you can attract additional borrowed capital.
If the effect has a minus sign, then measures should be taken to avoid losses.
American and European interpretations of the leverage effect
Two interpretations of the leverage effect are based on which accents in to a greater extent taken into account in the calculation. This is a more in-depth look at how the leverage ratio shows the magnitude of the impact on the financial results of a company.
The American model or concept considers financial leverage through net profit and profit received after the company has fulfilled all tax payments. This model takes into account the tax component.
The European concept is based on the efficiency of the use of borrowed capital. It examines the effects of using equity capital and compares with the effect of using debt capital. In other words, the concept is based on assessing the profitability of each type of capital.
Conclusion
Any company strives at least to achieve a break-even point, and as a maximum - to obtain high profitability indicators. To achieve all the goals set, there is not always enough equity capital. Many firms resort to borrowing for development. It is important to maintain a balance between equity capital and attracted capital. It is to determine to what extent this balance is being observed in the current time, and the indicator of financial leverage is used. It helps to determine to what extent the current capital structure allows you to work with additional borrowed funds.
A financial assessment of the company's stability indicators is essential for the successful organization and planning of its activities. Financial leverage is used quite frequently in this analysis. It allows you to assess the capital structure of an organization and optimize it.
The investment rating of the enterprise, the possibility of development, and the increase in the amount of profit depend on this. Therefore, in the process of planning the work of the analyzed object, this indicator plays an important role. The methodology for calculating it, the interpretation of the research results deserve special attention... The information obtained during the analysis is used by the company's management, founders and investors.
General concept
Financial leverage is an indicator that characterizes the degree of risk of a company with a certain ratio of its borrowed and own sources of financing. Translated from English "leverage" means "leverage". This suggests that when one factor changes, other indicators associated with it are influenced. This coefficient is directly proportional to financial risk organizations. This is a very informative technique.
In a market economy, the financial leverage indicator should be considered not from the point of view of the balance sheet valuation of equity capital, but from the position of its real valuation. For large enterprises that have been successfully operating in their industry for a long time, these indicators are quite different. When calculating the financial leverage ratio, it is very important to take into account all the nuances.
General sense
Applying a similar technique at the enterprise, it is possible to determine the relationship between the ratio of equity and debt capital and financial risk. Using free sources of support for activities, you can minimize risks.
At the same time, the stability of the company is the highest. By using paid borrowed capital, a company can increase its profits. The effect of financial leverage implies determining the level of accounts payable at which the return on total capital will be maximum.
On the one hand, using only its own financial sources, the company loses the opportunity to expand its production, but on the other hand, a too high level of paid resources in the overall structure of the balance sheet currency will lead to the inability to pay off its debts, and reduce the stability of the enterprise. Therefore, the leverage effect is very important when optimizing the balance structure.
Payment
Kfr = (1 - N) (KRA - K) З / С,
where H is the profit tax coefficient, KRA is the profitability of assets, K is the rate for using a loan, Z is borrowed capital, C is equity.
KRA = Gross Profit / Assets
In this technique, three factors are connected. (1 - H) - tax corrector. It does not depend on the enterprise. (KRA - K) - differential. З / С is financial leverage. This technique allows you to take into account all conditions, both external and internal. The result is obtained as a relative value.
Description of the components
The tax adjuster reflects the degree to which a change in income tax percentage affects the entire system. This indicator depends on the type of activity of the company. It cannot be lower than 13.5% for any organization.
The differential determines whether the total capital will be used profitably, taking into account the payment of the interest rate on loans. Financial leverage determines the degree of influence of paid funding sources on the effect of financial leverage.
With the general impact of these three elements of the system, it was found that the normatively fixed value of the coefficient is determined in the range from 0.5 to 0.7. The share of credit funds in the total structure of the balance sheet should not exceed 70%, otherwise the risk of non-repayment of debt increases, and financial stability decreases. But if its quantity is less than 50%, the company loses the opportunity to increase the amount of profit.
Calculation method
Operating and financial leverage is an integral part of determining the efficiency of a company's capital. Therefore, the calculation of these values is required. To calculate leverage, you can use the following formula:
FR = KRA - RSK, where RSK is the return on equity.
For this calculation, you must use the data that are presented in the balance sheet (form No. 1) and the statement of financial results (form No. 2). Based on this, you need to find all the components of the above formula. The return on assets is found as follows:
KRA = Net profit / Balance currency
KRA = s. 2400 (f. No. 2) / s. 1700 (f. No. 1)
To find your return on equity, you need to use the following equation:
RSK = Net profit / Equity
RSK = s. 2400 (f. No. 2) / s. 1300 (f. No. 1)
Calculation and interpretation of the result
To understand the above calculation methodology, you need to consider it at specific example... To do this, you can take the data of the accounting statements of the enterprise and evaluate them.
For example, the company's net profit in reporting period amounted to 39 350 thousand rubles. At the same time, the balance sheet currency was fixed at the level of 816,265 rubles, and its equity capital reached the level of 624,376 rubles. Based on the listed data, it is possible to find financial leverage:
CRA = 39 350/816 265 = 4.8%
RSK = 39 350/624 376 = 6.3%
FR = 6.3 - 4.8 = 1.5%
Based on the above calculations, we can say that the company, thanks to the use of credit funds, was able to increase its profit in the reporting period by 50%. The financial leverage of the return on equity is 50%, which is optimal for effective management of borrowed funds.
Having familiarized yourself with such a concept as financial leverage, one can come to the conclusion that the methodology for calculating it allows you to determine the most effective ratio of credit funds and own liabilities. This makes it possible for the organization to receive a large profit by optimizing its capital. Therefore, this technique is very important for the planning process.
For any enterprise, the priority is the rule that both its own and borrowed funds must provide returns in the form of profit (income). The action of financial leverage (leverage) characterizes the feasibility and efficiency of the enterprise's use of borrowed funds as a source of financing for economic activities.
Financial leverage effect lies in the fact that the company, using borrowed funds, changes the net profitability of its own funds. This effect arises from the discrepancy between the return on 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 there is enough cash to pay interest on a 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 = (Fik: sum of ZS) NS100,
Joint venture - the average calculated rate for a loan;
Fick - the actual financial costs of all loans received for the billing period (the amount of interest paid);
the amount of ЗС – total amount borrowed funds attracted in the billing period.
The general formula for calculating the effect of financial leverage can be expressed:
EFR = (1 - Hs) NS(Ra - SP) NS(ZK: SK),
EGF - the effect of financial leverage;
NS - the rate of income tax in shares of a unit;
Ra - return on assets;
Joint venture - the 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:
on different types the activities of the enterprise are differentiated tax rates;
on certain types the activities of the enterprise use income tax incentives;
individual subsidiaries (branches) of the enterprise carry out their activities 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 shaping 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 dynamics of this indicator, it requires systematic monitoring in the management process. The dynamism of the differential is due to a number of factors:
during a period of deteriorating financial market conditions, the cost of attracting borrowed funds can sharply increase and exceed the level of accounting profit generated by the company's assets;
a decrease in financial stability, in the process of intensive attraction of borrowed capital, leads to an increase in the risk of bankruptcy of an enterprise, which forces an increase in interest rates for loans, taking into account the premium for additional risk. The leverage differential can then be reduced to zero or even negative. As a result, the return on equity will decrease as part of the profits it generates will be used to service debt received at high interest rates;
during the period of deterioration of the situation on the product market, reduction in sales and the amount of accounting profit negative meaning differential can be formed even with stable interest rates by reducing the return on assets.
Thus, the negative value of the differential leads to a decrease in the return on equity, which makes its use ineffective.
The third component of the effect is debt ratio or financial leverage (ZK: 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, an increase in the debt ratio will lead to an even greater fall 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 a constant value of the debt ratio, 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 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 credit conditions.
To realize these favorable opportunities, it is necessary to establish the existence of a 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 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, you can do the following conclusions:
if the new borrowing brings the company an increase in the level of the effect of financial leverage, then it is beneficial for the company. 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 lender's risk is expressed by the value of the differential, since the higher the differential, the lower the credit risk of the bank. Conversely, if the differential becomes less than zero, then the effect of leverage will act to the detriment of the enterprise, that is, there will be a deduction from the return on equity, and investors will not have the desire to buy shares of the issuing enterprise with a negative differential.
Thus, an enterprise's debt to a commercial bank is neither a blessing nor an 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 only master if he has accurate information about the profitability of the company's assets. Otherwise, it is advisable for him to handle the debt ratio very carefully, weighing the consequences of new borrowings on the loan capital market.
The second way to calculate the effect of financial leverage can be viewed as a percentage (index) change in net income per ordinary share, and the resulting fluctuation in gross profit caused by this percentage change. In other words, the effect of financial leverage is determined by the following formula:
leverage = percentage change in net income per common share: percentage change in gross profit per common share.
The less the force of influence of financial leverage, the lower the financial risk associated with this enterprise. If borrowed funds are not attracted into circulation, then the force of influence of the financial leverage is equal to 1.
The greater the impact of financial leverage, the higher the level of financial risk for the company 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 a decrease in dividends on the shares of the issuing company belonging to him increases with high level financial risk.
The second way to measure the effect of financial leverage makes it possible to perform a conjugate calculation of the strength of the impact of financial leverage and establish the total (total) risk associated with the enterprise.
With inflation, if the debt and the interest on it are not indexed, the leverage increases as debt servicing and the debt itself are paid for with already depreciated money. It follows from this 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.
