/ / Financial leverage ratio (financial leverage)

The coefficient of financial leverage (financial leverage)

Any company seeks to increase its shareOn the market. In the process of formation and development, the firm creates and increases its own capital. At the same time, it is often necessary to attract external capital for a jump in growth or launch of new directions. For a modern economy with a well-developed banking sector and exchange structures, access to borrowed capital is not difficult.

Theory of the balance of capital

When borrowing funds, it is important to respectbalance between the obligations taken on payment and the goals set. Breaking it, you can get a significant decline in the pace of development and deterioration of all indicators.

coefficient of financial leverage

According to Modigliani-Miller theory, the presencea certain percentage of the borrowed capital in the structure of the total capital that the company has at its disposal is beneficial for the current and future development of the firm. Borrowed funds at an acceptable price of service allow to direct them to promising directions, in this case the effect of the money multiplier will work, when one nested unit will give an increment of an additional unit.

But if there is a high share of borrowed funds, the company may not fulfill its internal and external obligations by increasing the amount of loan servicing.

coefficient of leverage formula

Thus, the main task of the company, attracting outside capital, to calculate the optimal coefficient of financial leverage and create a balance in the overall structure of capital. It is very important.

Financial leverage (lever), definition

The financial leverage ratio isThe existing ratio between the two capitals in the company: own and attracted. For a better understanding, it is possible to formulate a definition in a different way. The financial leverage ratio is a measure of the risk that a company takes upon itself, creating a certain structure of sources of financing, that is, using both own and borrowed funds.

leverage ratio

For understanding: the word "leverage" is English, meaning "lever" in translation, that is why the leverage of the financial lever is often called "financial leverage". It is important to understand this and not to think that these words are different.

Components of the "shoulder"

The financial leverage factor takes into account several components that will affect its indicator and effects. Among them are:

  1. Taxes, namely, the tax burden thatcarries the firm in the conduct of its activities. Tax rates are set by the state, so the company on this issue can regulate the level of tax deductions only by changing the selected tax regimes.
  2. Financial leverage indicator. This is the ratio of borrowed funds to own. Already this indicator can give an initial idea of ​​the price of the attracted capital.
  3. The differential of financial leverage. Also, the compliance indicator, which is based on the difference in profitability of assets and interest that are paid for borrowed loans.

The formula of the financial lever

Calculate the coefficient of financial leverage, the formula of which is quite simple, can be as follows.

Lever arm = Size of borrowed capital / Own capital amount

At first glance, everything is clear and simple. It can be seen from the formula that the leverage ratio of a financial leverage is the ratio of all borrowed funds to own capital.

Leverage lever, effects

Leverage (financial) is associated with attractedborrowed funds, which are aimed at the development of the company, and profitability. Having determined the capital structure and having received the ratio, that is, having calculated the coefficient of the financial lever, the formula for the balance of which is presented, it is possible to estimate the efficiency of capital (that is, its profitability).

coefficient of financial leverage

The effect of the shoulder gives an understanding of how much will changeefficiency of equity due to the fact that there was an attraction of external capital into the turnover of the firm. To calculate the effect, there is an additional formula that takes into account the calculated value.

There are positive and negative effects of financial leverage.

The first is when the difference between profitabilityTotal capital after all taxes are paid, exceeds the interest rate for the loan granted. If the effect is greater than zero, then there is a positive, then increasing the leverage is beneficial and it is possible to attract additional borrowed capital.

If the effect has a minus sign, then measures should be taken to prevent loss.

American and European interpretation of the effect of leverage

Two interpretations of the effect of the lever are based on the fact,which accents are more accounted for in the calculation. This is a more in-depth consideration of how the ratio of financial leverage shows the impact on the company's financial results.

coefficient of financial leverage shows

The American model or concept is consideredfinancial leverage through net profit and profits earned after the company has completed all tax payments. In this model, the tax component is taken into account.

The European concept is based on efficiencyleveraging borrowed capital. It looks at the effects of using equity and compares it with the effect of leveraging borrowed capital. In other words, the concept is based on an assessment of the profitability of each type of capital.

Conclusion

Any firm aspires at least to achievebreak-even points, and as a maximum - to obtain high profitability indicators. To implement all of the goals set, not always enough equity. Very many firms resort to borrowing for development. It is important to balance the equity and the attracted. It is to determine how far this balance is being maintained in the current time, and the financial leverage indicator is applied. It helps to determine how current the structure of capital allows you to work with additional borrowed funds.

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