/ / Leverage leverage (financial leverage): the concept and methods of evaluation

# The lever of financial leverage (financial leverage): the concept and methods of evaluation

The leverage of the financial lever is used both onenterprise, to calculate the necessary loan amount for the provision of assets, and in the exchange trade. This tool helps to increase profits by attracting external sources of funds. However, its inept use can lead to a deterioration in the economic situation and even cause bankruptcy.

## What is a financial lever?

The lever of the financial lever is the ratioown assets in relation to borrowed funds. In fact, it expresses the ability of an enterprise to pay a debt in a timely and full amount. Banks and other credit institutions are required to calculate this parameter in order to determine the maximum loan amount that they can give to the enterprise. This definition is valid both for enterprises and for individual investors using this tool during the execution of speculative operations. Usually it is expressed in a fractional or percentage ratio to the funds received for debt or temporary use. For enterprises and banks, only formulas for calculating financial leverage are used, for investors - others. When using this tool, it is important to assess not only the benefits of the application, but also the risk that it brings.

## Purpose

Financial lever is needed in order to increasethe amount of working capital. Entrepreneurs resort to this financial instrument in order to expand economic activity. Solve with the help of a loan, you can and other financial problems associated with the activities of the enterprise.

The leverage of the financial lever is calculatedboth banks and individual businessmen. It is necessary in order to correctly assess the possible risks associated with the use of the shoulder, as well as to determine the amount by which the enterprise or investor can count.

## Calculation formula

To calculate the leverage of a leverage, the formula is as follows:

DFL = ((1-T) * (POA - p) * A) / E,

where DPL denotes the effect of the financial lever;

T - the interest rate of the profit tax in the country;

ROA - return on assets of the enterprise;

p - interest rate on the loan;

D - the amount of funds taken on credit;

E - own capital.

However, among the managers and accountants, another formula was used to calculate the leverage of the financial leverage. Data for calculations are taken from the financial statements. It has the following form:

DFL = POE - ROA,

where ROE is the return on equity. This parameter is calculated by the formula:

ROE = Net profit / Total for Section 3.

The profitability of the company's assets is calculated by the formula:

ROA = Net profit / Total balance.

This method is convenient in that all calculations can be performedautomate. In addition, it is only possible to assess the effect of using the leverage of the leverage, and not to calculate the amount necessary to expand or maintain a stable operation of the enterprise. This formula is used not for the analysis of past and current activities, but for forecasting.

## Calculation example

In order to make the above formulas clearer, the calculations performed for the company "Snezhka" based on the data of its annual report are given below.

POE = - 21055/480171 = -0.044;

POA = -21055 / 1488480 = -0.014;

DPL = -0.044 + 0.014 = -0.03;

How to interpret the information received? What does the result mean? If the ratio of debt to equity ratio is less than 0.8, the state of the enterprise is considered not quite stable. The enterprise does not have enough current assets that it can realize in order to repay short-term loans. If it is more than 0.8 or equal to it, then the risk is insignificant and the enterprise is not threatened, as it will be able to timely realize its assets and make a payment if it is required.

As can be seen from the calculations, OJSC "Snezhka"not only can not pay off current debts, but it also has no right to expect a new loan from the bank to expand its activities. Here, at least pay off the debts that have arisen. This situation is observed at many Russian enterprises, especially during the last 2-3 years. However, for the bank this is not a reason to risk it again. To determine whether the financial lever will help to rectify the situation, calculations should be made not in one year but in 3-5 years of operation of the enterprise.

## What do the data obtained during the calculations mean?

The ratio of borrowed andown funds. But the calculations are just half the job. The information obtained must still be able to analyze. On the extent to which the analysis and decision will be correct, the degree of risk depends. For the bank - the return of loans issued, for the businessman - the stable operation of the enterprise and the probability of bankruptcy.

As can be seen from the example given, the enterprisehas serious problems. In the current period, it received a net loss. The organization can take a loan from the bank to cover the arrears arising from the received loss. But this threatens the loss of stability and the risk of delinquency of payments on loans, which, in turn, will lead to unforeseen expenses in the form of payment of penalties and fines.

If an entrepreneur knows in advance the amount of the loan that he can rely on, he can better plan where and on what he can spend these funds. This is the benefit of such calculations.

## Using financial leverage on the stock and currency exchange

The broadest application of the leverage of financialleveraged in trading transactions on the stock and currency exchanges. Attracting borrowed funds, the investor can acquire more, and therefore, get a higher profit. But using the lever in such risky operations often leads to large losses in a short time.

When calculating the shoulder for investors conductingspeculative operations on the stock exchange, the formula is not used. In this case, the leverage of the financial leverage is the ratio between the amount of capital and the loan that is provided for temporary use. The ratio can be as follows: 1:10, 1:50, etc. The higher the ratio, the higher the risk. The amount of the deposit is multiplied by the size of the lever. Since fluctuations on the stock exchange are usually only a few percent, the leverage allows you to increase the amount of money used in tens and hundreds of times, which makes the profit (loss) significant.