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Financial leverage characterizes the ratio of all assets to equity, and the effect of financial leverage is calculated accordingly by multiplying it by the economic profitability indicator, that is, it characterizes profitability equity(the ratio of profit to equity).
The effect of financial leverage is an increment to the return on equity obtained through the use of a loan, despite the payment of the latter.
An enterprise using only its own funds limits their profitability to about two-thirds of economic profitability.
РСС - net profitability of own funds;
ER - economic profitability.
An enterprise using a loan increases or decreases the return on equity, depending on the ratio of own and borrowed funds in liabilities and on the interest rate. Then there is the effect of financial leverage (EFF):
(3)
Consider the mechanism of financial leverage. In the mechanism, a differential and a shoulder of financial leverage are distinguished.
Differential - the difference between the economic return on assets and the average calculated interest rate (AMIR) on borrowed funds.
Due to taxation, unfortunately, only two-thirds of the differential remain (1/3 is the profit tax rate).
Shoulder of financial leverage - characterizes the strength of the impact of financial leverage.
(4)
Let's combine both components of the effect of financial leverage and get:
(5)
(6)
Thus, the first way to calculate the level of financial leverage effect is:
(7)
The loan should lead to an increase in financial leverage. In the absence of such an increase, it is better not to take a loan at all, or at least calculate the maximum maximum amount of credit that leads to growth.
If the loan rate is higher than the level of economic profitability of the tourist enterprise, then the increase in production volume due to this loan will not lead to the return of the loan, but to the transformation of the enterprise from profitable to unprofitable.
Here we should highlight two important rules:
1. If a new borrowing brings the company an increase in the level of financial leverage, then such borrowing is profitable. But at the same time, it is necessary to monitor the state of the differential: when increasing the leverage of financial leverage, a banker is inclined to compensate for the increase in his risk by increasing the price of his “commodity” - a loan.
2. 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.
You should not increase the financial leverage at any cost, you need to adjust it depending on the differential. The differential must not be negative. And the effect of financial leverage in world practice should be equal to 0.3 - 0.5 of the level of economic return on assets.
Financial leverage allows you to assess the impact of the capital structure of the enterprise on profit. The calculation of this indicator is expedient from the point of view of assessing the effectiveness of the past and planning the future financial activities of the enterprise.
Advantage rational use financial leverage is the ability to generate income from the use of capital borrowed at a fixed interest in investment activities that bring a higher interest than paid. In practice, the value of financial leverage is affected by the scope of the enterprise, legal and credit restrictions, and so on. Too high financial leverage is dangerous for shareholders, as it involves a significant amount of risk.
Commercial risk means uncertainty about a possible result, the uncertainty of this result of activity. Recall that risks are divided into two types: pure and speculative.
Financial risks are speculative risks. An investor, making a venture capital investment, knows in advance that only two types of results are possible for him: income or loss. A feature of financial risk is the likelihood of damage as a result of any operations in the financial, credit and exchange areas, transactions with stock securities, that is, the risk that follows from the nature of these operations. Financial risks include credit risk, interest rate risk, currency risk, risk of lost financial profit.
The concept of financial risk is closely related to the category of financial leverage. Financial risk is the risk associated with possible disadvantage funds to pay interest on long-term loans and borrowings. The increase in financial leverage is accompanied by an increase in the degree of riskiness of this enterprise. This is manifested in the fact that for two tourist enterprises with the same volume of production, but different level financial leverage, the variation in net profit due to changes in the volume of production will not be the same - it will be greater for an enterprise with a higher level of financial leverage.
The effect of financial leverage can also be interpreted as the change in net income per ordinary share (as a percentage) generated by a given change in the net result of the operation of investments (also as a percentage). This perception of the effect of financial leverage is typical mainly for the American school of financial management.
Using this formula, they answer the question of how many percent the net profit per ordinary share will change if the net result of the operation of investments (profitability) changes by one percent.
After a series of transformations, you can go to the formula of the following form:
Hence the conclusion: the higher the interest and the lower the profit, the greater the strength of the financial leverage and the higher the financial risk.
When forming a rational structure of sources of funds, one must proceed from the following fact: to find such a ratio between borrowed and own funds, in which the value of the enterprise's share will be the highest. This, in turn, becomes possible with a sufficiently high, but not excessive effect of financial leverage. The level of debt is for the investor a market indicator of the well-being of the enterprise. An extremely high proportion of borrowed funds in liabilities indicates an increased risk of bankruptcy. If the tourist enterprise prefers to manage with its own funds, then the risk of bankruptcy is limited, but investors, receiving relatively modest dividends, believe that the enterprise does not pursue the goal of maximizing profits, and begin to dump shares, reducing the market value of the enterprise.
There are two important rules:
1. If the net result of the operation of investments per share is small (and at the same time the financial leverage differential is usually negative, the net return on equity and the dividend level are lower), then it is more profitable to increase equity through the issuance of shares than to take out a loan: attracting borrowed funds costs the company more than raising its own funds. However, there may be difficulties in the process of initial public offering.
2. If the net result of exploitation of investments per share is large (and at the same time the financial leverage differential is most often positive, the net return on equity and the dividend level are increased), then it is more profitable to take a loan than to increase own funds: raising borrowed funds costs the enterprise cheaper than raising own funds. Very important: it is necessary to control the strength of the impact of financial and operational leverage in the event of their possible simultaneous increase.
Therefore, you should start with calculations net profitability equity and net earnings per share.
(10)
1. The pace of increasing the turnover of the enterprise. Increased turnover growth rates also require increased funding. This is due to an increase in variable, and often fixed costs, an almost inevitable swelling accounts receivable, as well as with many other very different reasons, including cost-push inflation. Therefore, on a steep rise in turnover, firms tend to rely not on internal, but on external financing, with an emphasis on increasing the share of borrowed funds in it, since issue costs, initial public offering costs and subsequent dividend payments most often exceed the value of debt instruments;
2. Stability of turnover dynamics. An enterprise with a stable turnover can afford a relatively larger share of borrowed funds in liabilities and more fixed costs;
3. Level and dynamics of profitability. It is noted that the most profitable enterprises have a relatively low share of debt financing on average over a long period. The enterprise generates sufficient profits to finance development and pay dividends, and is increasingly self-sufficient;
4. Structure of assets. If an enterprise has significant general-purpose assets that, by their very nature, can serve as collateral for loans, then increasing the share of borrowed funds in the liability structure is quite logical;
5. The severity of taxation. The higher the income tax, the less tax incentives and opportunities to use accelerated depreciation, the more attractive debt financing for the enterprise due to attributing at least part of the interest for the loan to the cost;
6. Attitude of creditors to the enterprise. The play of supply and demand in the money and financial markets determines the average terms of credit financing. But the specific conditions for granting this loan may deviate from the average, depending on the financial and economic situation of the enterprise. Whether bankers compete for the right to provide a loan to an enterprise, or money has to be begged from creditors - that is the question. The real possibilities of the enterprise to form the desired structure of funds largely depend on the answer to it;
8. Acceptable degree of risk for the leaders of the enterprise. The people at the helm may be more or less conservative in terms of risk tolerance when making financial decisions;
9. Strategic target financial settings of the enterprise in the context of its actually achieved financial and economic position;
10. The state of the market for short- and long-term capital. With an unfavorable situation in the money and capital market, it is often necessary to simply obey the circumstances, postponing until better times the formation of a rational structure of sources of funds;
11. Financial flexibility of the enterprise.
Example.
Determining the amount of financial leverage economic activity enterprises on the example of the hotel "Rus". Let us determine the expediency of the size of the attracted credit. The structure of enterprise funds is presented in Table 1.
Table 1
Structure financial resources enterprises of the hotel "Rus"
| Indicator | Value |
| Initial values | |
| Hotel asset minus credit debt, mln. rub. | 100,00 |
| Borrowed funds, million rubles | 40,00 |
| Own funds, million rubles | 60,00 |
| Net result of investment exploitation, mln. rub. | 9,80 |
| Debt servicing costs, million rubles | 3,50 |
| Estimated values | |
| Economic profitability of own funds, % | 9,80 |
| Average calculated interest rate, % | 8,75 |
| Financial leverage differential excluding income tax, % | 1,05 |
| Financial leverage differential including income tax, % | 0,7 |
| Financial Leverage | 0,67 |
| Effect of financial leverage, % | 0,47 |
Based on these data, the following conclusion can be drawn: the Rus Hotel can take out loans, but the differential is close to zero. Minor changes in the production process or higher interest rates can reverse the effect of leverage. There may come a time when the differential becomes less than zero. Then the effect of financial leverage will act to the detriment of the hotel.
Ural Socio-Economic Institute
Academy of Labor and Social Relations
Department of Financial Management
Course work
Course: Financial Management
Topic: The effect of financial leverage: financial and economic content, calculation methodology and scope for adoption management decisions.
Form of study: Correspondence
Specialty: Finance and Credit
Course: 3, Group: FSZ-302B
Completed by: Mingaleev Dmitry Rafailovich
Chelyabinsk 2009
Introduction
1. The essence of the effect of financial leverage and calculation methods
1.1 The first way to calculate financial leverage
1.2 The second method of calculating financial leverage
1.3 The third method of calculating financial leverage
2. Coupled effect of operational and financial leverage
3. Strength of financial leverage in Russia
3.1 Controllable factors
3.2 Business size matters
3.3 Structure of external factors influencing the effect of financial leverage
Conclusion
Bibliography
Introduction
Profit is the simplest and at the same time the most complex economic category. She received a new content in the conditions of modern economic development countries, the formation of real independence of business entities. Being the main driving force market economy, it ensures the interests of the state, owners and personnel of the enterprise. Therefore, one of the urgent tasks modern stage is the mastery of leaders and financial managers modern methods of effective management of profit formation in the process of production, investment and financial activities of the enterprise. The creation and operation of any enterprise is simply a process of investing financial resources on a long-term basis in order to make a profit. Of priority importance is the rule that both own and borrowed funds must provide a return in the form of profit. Competent, effective management formation of profit involves the construction at the enterprise of appropriate organizational and methodological systems for ensuring this management, knowledge of the main mechanisms for generating profit, the use of modern methods of its analysis and planning. One of the main mechanisms for the implementation of this task is the financial lever
The purpose of this work is to study the essence of the effect of financial leverage.
Tasks include:
Consider the financial and economic content
Consider calculation methods
Consider the scope
1. The essence of the effect of financial leverage and calculation methods
Profit formation management involves the use of appropriate organizational and methodological systems, knowledge of the main mechanisms of profit formation and modern methods of its analysis and planning. When using a bank loan or issuing debt securities, interest rates and the amount of debt remain constant during the term of the loan agreement or the term of circulation of securities. The costs associated with servicing the debt do not depend on the volume of production and sales of products, but directly affect the amount of profit remaining at the disposal of the enterprise. Since interest on bank loans and debt securities is charged to enterprises (operating expenses), using debt as a source of financing is cheaper for the enterprise than other sources that are paid out of net profit (for example, dividends on shares). However, an increase in the share of borrowed funds in the capital structure increases the risk of insolvency of the enterprise. This should be taken into account when choosing funding sources. It is necessary to determine the rational combination between own and borrowed funds and the degree of its impact on the profit of the enterprise. One of the main mechanisms for achieving this goal is financial leverage.
Financial leverage (leverage) characterizes the use of borrowed funds by the enterprise, which affects the value of return on equity. Financial leverage is an objective factor that arises with the advent of borrowed funds in the amount of capital used by the enterprise, allowing it to receive additional profit on equity.
The idea of financial leverage American concept consists in assessing the level of risk for fluctuations in net profit caused by the constant value of the company's debt service costs. Its action is manifested in the fact that any change in operating profit (earnings before interest and taxes) generates a more significant change in net income. Quantitatively, this dependence is characterized by the indicator of the strength of the impact of financial leverage (SVFR):
Interpretation of the financial leverage ratio: it shows how many times earnings before interest and taxes exceed net income. The lower limit of the coefficient is one. The greater the relative amount of borrowed funds attracted by the enterprise, the greater the amount of interest paid on them, the higher the impact of financial leverage, the more variable the net profit. Thus, an increase in the share of borrowed financial resources in the total amount of long-term sources of funds, which, by definition, is equivalent to an increase in the strength of the impact of financial leverage, ceteris paribus, leads to greater financial instability, expressed in less predictable net profit. Since the payment of interest, in contrast to, for example, the payment of dividends, is mandatory, then with a relatively high level of financial leverage, even a slight decrease in profits may have adverse consequences compared to a situation where the level of financial leverage is low.
The higher the force of financial leverage, the more non-linear the relationship between net income and earnings before interest and taxes becomes. A slight change (increase or decrease) in earnings before interest and taxes under conditions of high financial leverage can lead to a significant change in net income.
The increase in financial leverage is accompanied by an increase in the degree of financial risk of the enterprise associated with a possible lack of funds to pay interest on loans and borrowings. For two enterprises with the same volume of production, but different levels of financial leverage, the variation in net profit due to changes in the volume of production is not the same - it is greater for the enterprise with a higher value of the level of financial leverage.
European concept of financial leverage characterized by an indicator of the effect of financial leverage, reflecting the level of additionally generated profit on equity with a different share of the use of borrowed funds. This method of calculation is widely used in the countries of continental Europe (France, Germany, etc.).
The effect of financial leverage(EFF) shows by what percentage the return on equity increases by attracting borrowed funds into the turnover of the enterprise and is calculated by the formula:
EGF \u003d (1-Np) * (Ra-Tszk) * ZK / SK
where N p - the rate of income tax, in fractions of units;
Rp - return on assets (the ratio of the amount of profit before interest and taxes to the average annual amount of assets), in fractions of units;
C zk - weighted average price of borrowed capital, in fractions of units;
ZK - average annual cost loan capital; SC is the average annual cost of equity capital.
There are three components in the above formula for calculating the effect of financial leverage:
♦ financial leverage tax corrector(l-Np), which shows the extent to which the effect of financial leverage is manifested in connection with different levels of taxation of profits;
♦ leverage differential(ra -C, k), which characterizes the difference between the profitability of the enterprise's assets and the weighted average calculated interest rate on loans and borrowings;
♦ financial leverage ZK/SK
the amount of borrowed capital per ruble of the company's own capital. In terms of inflation, the formation of the effect of financial leverage is proposed to be considered depending on the rate of inflation. If the amount of the company's debt and interest on loans and borrowings are not indexed, the effect of financial leverage increases, since debt servicing and the debt itself are paid for with already depreciated money:
EGF \u003d ((1-Np) * (Ra - Tsk / 1 + i) * ZK / SK,
where i - characteristic of inflation (inflationary rate of price growth), in fractions of units.
In the process of managing financial leverage, a tax corrector can be used in the following cases:
♦ if by various types activities of the enterprise differentiated tax rates are established;
♦ if the enterprise uses income tax benefits for certain types of activities;
♦ if individual subsidiaries of the enterprise operate in the free economic zones of their country, where there is a preferential income tax regime, as well as in foreign countries.
In these cases, by influencing the sectoral or regional structure of production and, accordingly, the composition of profit in terms of its taxation level, it is possible, by reducing the average profit tax rate, to reduce the impact of the financial leverage tax corrector on its effect (ceteris paribus).
The financial leverage differential is a condition for the emergence of the effect of financial leverage. A positive EGF occurs in cases where the return on total capital (Ra) exceeds the weighted average price of borrowed resources (Czk)
The difference between the return on total capital and the cost of borrowed funds will increase the return on equity. Under such conditions, it is beneficial to increase the financial leverage, i.e. the share of borrowed funds in the capital structure of the enterprise. If R a< Ц зк, создается отрицательный ЭФР, в результате чего происходит уменьшение рентабельности собственного капитала, что в конечном итоге может стать причиной банкротства предприятия.
The higher the positive value of the differential of financial leverage, the higher, other things being equal, its effect.
Due to the high dynamism of this indicator, it requires constant monitoring in the process of profit management. This dynamism is driven by a number of factors:
♦ in the period of deterioration of the financial market (decrease in the supply of loan capital) the cost of raising borrowed funds may increase sharply, exceeding the level of accounting profit generated by the company's assets;
♦ Decrease in financial stability in the process of intensive attraction of borrowed capital leads to an increase in the risk of its bankruptcy, which forces lenders to raise interest rates for a loan, taking into account the inclusion of a premium for additional financial risk in them. As a result, the financial leverage differential can 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 directed to servicing debt at high interest rates;
♦ in addition, in the period of deterioration of the situation on the commodity market and reduction in sales, the amount of accounting profit also falls. Under such conditions, a negative value of the differential can form even with stable interest rates due to a decrease in the return on assets.
It can be concluded that the negative value of the financial leverage differential for any of the above reasons leads to a decrease in the return on equity, the use of borrowed capital by an enterprise has a negative effect.
Financial Leverage characterizes the strength of the impact of financial leverage. This coefficient multiplies the positive or negative effect obtained due to the differential. With a positive value of the differential, any increase in the coefficient of financial leverage causes an even greater increase in its effect and return on equity, and with a negative value of the differential, an increase in the coefficient of financial leverage leads to an even greater decrease in its effect and return on equity.
Thus, with a constant differential, the coefficient of financial leverage is the main generator of both the increase in the amount and level of return on equity, and the financial risk of losing this profit.
Knowledge of the mechanism of the impact of financial leverage on the level of financial risk and profitability of equity capital allows you to purposefully manage both the cost and the capital structure of the enterprise.
1.1 The first way to calculate financial leverage
The essence of financial leverage is manifested in the impact of debt on the profitability of the enterprise.
As mentioned above, the grouping of expenses in the income statement into production and financial expenses allows us to identify two main groups of factors affecting profit:
1) the volume, structure and efficiency of managing the costs associated with the financing of current and non-current assets;
2) the volume, structure and cost of funding sources [enterprise funds.
Based on the profit indicators, the profitability indicators of the enterprise are calculated. Thus, the volume, structure and cost of funding sources affect the profitability of the enterprise.
Enterprises resort to various sources of financing, including through the placement of shares or the attraction of loans and borrowings. attraction share capital is not limited by any timeframe, therefore, the joint-stock company considers the attracted funds of shareholders to be its own capital.
attraction Money through loans and borrowings is limited to certain periods. However, their use helps to maintain control over the management of a joint stock company, which can be lost due to the emergence of new shareholders.
An enterprise can operate by financing its expenses only from its own capital, but no enterprise can operate only on borrowed funds. As a rule, the enterprise uses both sources, the ratio between which forms the structure of the liability. The structure of liabilities is called the financial structure, the structure of long-term liabilities is called the capital structure. Thus, the capital structure is an integral part of the financial structure. Long-term liabilities that make up the capital structure and include equity and a share of term debt capital are called permanent capital
Capital structure= financial structure - short-term debt = long-term liabilities (fixed capital)
When forming the financial structure (the structure of liabilities in general), it is important to determine:
1) the ratio between long-term and short-term borrowed funds;
2) the share of each of the long-term sources (own and borrowed capital) as a result of liabilities.
The use of borrowed funds as a source of asset financing creates the effect of financial leverage.
The effect of financial leverage: the use of long-term borrowed funds, despite their payment, leads to an increase in the return on equity.
Recall that the profitability of an enterprise is assessed using profitability ratios, including sales profitability ratios, asset profitability (profit/asset) and equity return (profit/equity).
The relationship between the return on equity and the return on assets indicates the importance of the company's debt.
Return on equity ratio (in the case of using borrowed funds) = profit - interest on debt repayment debt capital / equity capital
We remind you that the cost of debt can be expressed in relative and absolute terms, i.e. directly in interest accrued on a loan or loan, and in monetary terms - the amount of interest payments, which is calculated by multiplying the remaining amount of debt by the interest rate reduced to the period of use.
Return on assets ratio- profit/assets
Let's transform this formula to get the profit value:
assets
Assets can be expressed in terms of the value of their funding sources, i.e. through long-term liabilities (the sum of own and borrowed capital):
Assets = equity+ borrowed capital
Substitute the resulting expression of assets into the profit formula:
Profit = return on assets(own capital + debt capital)
And finally, we substitute the resulting expression of profit into the previously converted formula for return on equity:
Return on equity = return on assets (equity+ borrowed capital) - interest on debt repayment borrowed capital / equity capital
Return on equity= return on assets equity + return on assets debt capital - interest on debt repayment debt capital / equity capital
Return on equity = return on assets equity + borrowed capital (return on assets - interest on debt repayment) / equity
Thus, the value of the return on equity ratio increases with the growth of debt as long as the value of the return on assets is higher than the interest rate on long-term borrowed funds. This phenomenon has been named effect of financial leverage.
An enterprise that finances its activities only from its own funds, the return on equity is approximately 2/3 of the return on assets; an enterprise using borrowed funds has 2/3 of the return on assets plus the effect of financial leverage. At the same time, the return on equity increases or decreases depending on the change in the capital structure (the ratio of own and long-term borrowed funds) and the interest rate, which is the cost of attracting long-term borrowed funds. This manifests itself financial leverage.
Quantitative assessment of the impact of financial leverage is carried out using the following formula:
Strength of financial leverage = 2/3 (return on assets - interest rate on loans and borrowings)(long-term debt / equity)
It follows from the above formula that the effect of financial leverage occurs when there is a discrepancy between the return on assets and the interest rate, which is the price (cost) of long-term borrowed funds. In this case, the annual interest rate is reduced to the period of use of the loan and is called the average interest rate.
Average interest rate- the amount of interest on all long-term loans and borrowings for the analyzed period / the total amount of attracted loans and borrowings in the analyzed period 100%
The formula for the effect of financial leverage includes two main indicators:
1) the difference between the return on assets and the average interest rate, called the differential;
2) the ratio of long-term debt and equity, called the leverage.
Based on this, the formula for the effect of financial leverage can be written as follows.
Strength of financial leverage = 2/3 of the differentiallever arm
After taxes are paid, 2/3 of the differential remains. The formula for the impact of financial leverage, taking into account taxes paid, can be represented as follows:
(1 - profit tax rate) 2/3 differential * leverage
It is possible to increase the profitability of own funds through new borrowings only by controlling the state of the differential, the value of which can be:
1) positive if the return on assets is higher than the average interest rate (the effect of financial leverage is positive);
2) zero, if the return on assets is equal to the average interest rate (the effect of financial leverage is zero);
3) negative, if the return on assets is below the average interest rate (the effect of financial leverage is negative).
Thus, the value of the return on equity will increase as borrowed funds increase until the average interest rate becomes equal to the value of the return on assets. At the moment of equality of the average interest rate and the return on assets, the leverage effect will “turn over”, and with a further increase in borrowed funds, instead of increasing profits and increasing profitability, there will be real losses and unprofitability of the enterprise.
Like any other indicator, the level of financial leverage effect should have an optimal value. It is believed that the optimal level is 1/3-1/3 of the value of return on assets.
1.2 The second method of calculating financial leverage
By analogy with the production (operational) leverage, the impact of financial leverage can be defined as the ratio of the rate of change in net and gross profit.
= rate of change in net profit / rate of change in gross profit
In this case, the strength of the impact of financial leverage implies the degree of sensitivity of net profit to changes in gross profit.
1.3 The third method of calculating financial leverage
Leverage can also be defined as the percentage change in net income per ordinary share outstanding due to a change in the net operating result of the investment (earnings before interest and taxes).
The power of financial leverage= percentage change in net income per common share outstanding / percentage change in net investment operating result
Consider the indicators included in the formula of financial leverage.
The concept of earnings per ordinary share in circulation.
Net income ratio per share outstanding = net income - amount of dividends on preferred shares / number of ordinary shares outstanding
Number of common shares outstanding = total number of common shares outstanding - treasury common shares in the company's portfolio
Recall that the earnings per share ratio is one of the most important indicators that affect the market value of the company's shares. However, it must be remembered that:
1) profit is an object of manipulation and, depending on the methods used accounting can be artificially overestimated (FIFO method) or underestimated (LIFO method);
2) the immediate source of payment of dividends is not profit, but cash;
3) buying its own shares, the company reduces their number in circulation, and therefore increases the amount of profit per share.
The concept of the net result of the operation of the investment. Western financial management uses four main indicators that characterize the financial performance of an enterprise:
1) added value;
2) gross result of exploitation of investments;
3) net result of exploitation of investments;
4) return on assets.
1. Value Added (NA) represents the difference between the cost of goods produced and the cost of consumed raw materials, materials and services.
Value added - the value of manufactured products - the cost of consumed raw materials, materials and services
In its economic essence, added value. represents that part of the value of the social product which is newly created in the process of production. Another part of the value of the social product is the cost of raw materials, materials, electricity, work force etc.
2. Gross Result of Exploitation of Investments (BREI) is the difference between value added and labor costs (direct and indirect). Overspending tax may also be deducted from the gross result wages.
Gross return on investment =value added - expenses (direct and indirect) for wages - tax on wage overruns
The gross result of investment exploitation (BREI) is an intermediate indicator of the financial performance of an enterprise, namely, an indicator of the sufficiency of funds to cover the costs taken into account in its calculation.
3. Net result of exploitation of investments (NREI) is the difference between the gross operating result of the investment and the cost of restoring fixed assets. In its economic essence, the gross result of the exploitation of investments is nothing more than profit before interest and taxes. In practice, the balance sheet profit is often taken as the net result of the operation of investments, which is wrong, since the balance sheet profit (profit transferred to the balance sheet) is profit after paying not only interest and taxes, but also dividends.
Net result of exploitation of investments= gross result of operating the investment - the cost of restoring fixed assets (depreciation)
4. Return on assets (RA). Profitability is the ratio of the result to the funds spent. Return on assets refers to the ratio of profit to
payment of interest and taxes on assets - funds spent on production.
Return on assets= (net operating result of investments / assets) 100%
Transforming the formula for return on assets will allow you to obtain formulas for the profitability of sales and asset turnover. To do this, we use a simple mathematical rule: multiplying the numerator and denominator of a fraction by the same number will not change the value of the fraction. Multiply the numerator and denominator of the fraction (return on assets) by the volume of sales and divide the resulting figure into two fractions:
Return on assets= (net result of investment operation sales volume / assets sales volume) 100%= (net result of investment operation / sales volume) (sales volume / assets) 100%
The resulting formula for return on assets as a whole is called the Dupont formula. The indicators included in this formula have their names and their meaning.
The ratio of the net result of the operation of investments to the volume of sales is called commercial margin. In essence, this coefficient is nothing but the coefficient of profitability of the implementation.
The indicator "sales volume / assets" is called the transformation ratio, in essence, this ratio is nothing but the asset turnover ratio.
Thus, the regulation of the return on assets is reduced to the regulation of the commercial margin (sales profitability) and the transformation ratio (asset turnover).
But back to financial leverage. Let us substitute the formulas for net profit per ordinary share in circulation and the net result of the operation of investments into the formula for the strength of financial leverage
Strength of financial leverage = percentage change in net income per ordinary share outstanding / percentage change in net investment operating result = (net income - preferred dividends / number of ordinary shares outstanding) / (net investment operating result / assets) 100%
This formula makes it possible to estimate by what percentage the net profit per one ordinary share in circulation will change if the net result of investment operation changes by one percent.
2. Coupled effect of operational and financial leverage
The effect of production (operational) leverage can be combined with the effect of financial leverage and obtain the conjugated effect of production (operational) and financial leverage, i.e. production-financial, or general, leverage.
At the same time, a synergistic effect is manifested, which consists in the fact that the value of the aggregate indicator is greater than arithmetic sum values of individual indicators.
Thus, the value of the production-financial (general) leverage is greater than the arithmetic sum of the values of the production (operational) and financial leverage indicators.
Leverage as a measure of risk
Leverage is not only a method of asset management aimed at increasing profits, but also a measure of the risk associated with investments in the activities of the enterprise. At the same time, there are:
1) entrepreneurial risk, measured by the production (operational) lever;
2) financial risk measured by financial leverage;
3) total risk, measured by the general (production-financial) leverage.
Financial leverage is not only a method of managing the profit and profitability of an enterprise, but also a measure of risk.
The greater the force of the impact of the financial lever, the greater, and, conversely, the smaller the force of the impact of the financial lever, the less:
1) for shareholders - the risk of a fall in the level of dividends and the share price;
2) for creditors - the risk of non-repayment of the loan and non-payment of interest.
Combining the actions of production (operational) I and financial levers means an increase in the overall risk, the risk associated with the enterprise. In this case, the effect of synergy is manifested, i.e. the value of the total risk is greater than the arithmetic sum of indicators of production (operational) and financial risks.
3. Strength of financial leverage in Russia
In the course of a large-scale study of the possibilities of domestic business in managing the capital structure, at the first stage, the question was investigated: do Russian companies manage their capital structure and are they aware, building appropriate financial strategies, of the financial risk that grows with an increase in borrowed capital? At the second stage, it was studied whether domestic business itself is a real subject of capital structure management and to what extent the effect of financial leverage depends on external factors?
Who determines the structure of capital in Russia - the domestic business itself or, perhaps, it spontaneously develops under the influence of external circumstances? It is obvious that businesses are trying to play in the financial market using different funding strategies. The differences in the implemented strategies are determined, first of all, by the scale of the business. In general, it can be stated that Russian companies and corporations have sufficiently mastered financial strategies, including capital structure management, but after 2003, the interests of large business focused on external borrowing, while small and medium-sized businesses maintained and strengthened their positions in domestic financial market.
The mechanisms for raising capital by large businesses differ from those available to medium and small businesses. If representatives of the former bring their financial assets to international stock exchanges and receive cheap loans from the largest European and American banks, then small businesses are content with very expensive loans from domestic banks. The picture emerges as follows: today big business and banks are faced with a liquidity crisis that began in the world in the second half of 2007, and finally realized the growing financial risk. The price for underestimating the risk will apparently have to be paid by medium and small businesses, and, ultimately, by the population of Russia. Terms of long-term lending in the domestic financial market have tightened - the cost of loans after a long period of decline has risen sharply, the volumes have declined.
The observed differentiation of financial strategies, depending on the scale of domestic business entities, is related to the degree of influence of factors on them. external environment. The more resistant a company is to external factors, the more independent it is in managing its capital structure. Therefore, to begin with, we will determine which of the factors of the external and internal environment the domestic business can use (and really uses) to increase the effect and strength of the impact of financial leverage.
3.1 Controllable factors
The EGF is positive if the leverage differential is positive, the return on the company's assets exceeds the cost of borrowed capital. The company can influence the value of the differential, but to a limited extent: on the one hand, increasing the efficiency of production (scale effect), and on the other hand, through access to sources of cheap borrowed capital. The financial leverage differential is an important informational impulse not only for business, but also for potential creditors, as it allows you to determine the risk of providing new loans to a company. The larger the differential, the lower the risk for the lender and vice versa. Large financial leverage means significant risk for both the borrower and the lender.
The magnitude of the impact of financial leverage quite accurately shows the degree of financial risk associated with the firm. The greater the share of costs in taxable income (before paying interest on servicing borrowed capital), the greater the impact of financial leverage and the higher the risk of default on the loan.
The financial risk generated by financial leverage consists of the risk of the company's return on assets falling below the cost of borrowed capital (the differential becomes negative) and the risk of reaching such a leverage value when the company is no longer able to service the borrowed capital (the borrower defaults).
Among the parameters influencing the EFR and SVFR, we single out those that companies can manage to some extent, and uncontrollable ones related to external factors. The parameter of return on assets can be attributed to the managed, although not to the full extent, since its value is determined by the qualifications of management, the ability of managers to use favorable market conditions for the benefit of the company, not only in the sale of products, but also by attracting external capital. The average cost of borrowed capital is also a manageable factor, albeit indirectly: the price and other parameters of the availability of loans for a company are largely determined by its credit rating, credit history, growth dynamics, and sometimes by scale and industry affiliation. Finally, the leverage of the financial lever, that is, the ratio of debt and equity capital (its structure) is determined by the company itself.
The parameters of the effect of financial leverage not controlled by companies include the income tax rate.
Is it possible, by varying these parameters, to increase the EGF? Does the size of the company's business affect its ability to manage, for example, return on assets?
It is obvious that the profitability of assets of companies supplying products for export, under favorable market conditions, is far from always the result of a single control action. Today, companies engaged in the extraction of fuel and energy and other minerals, the production of coke, oil products, chemical, metallurgical production and the production of finished metal products or providing communication services receive and consume rent in favorable market conditions. Almost all business in these areas of activity is represented by large and large corporations, often with solid state participation.
The exceptionally favorable market situation prevailing in the world markets contributes to the increase in the profitability of exporting companies not only when selling products, but also when attracting inexpensive capital in external financial markets. Indeed, until recently these corporations had access to external long-term loans at a rate of 6-7%, while in Russian banks the cost of loans is 2-2.5 times higher. It was often difficult for the largest Russian companies to refuse loans, as they were presented to them, one might say, on a silver platter: “Foreigners literally ran after Russian banks, primarily with state capital, offering them money ... There are many free money, and Russia remains an attractive country for investment - a solid trade surplus, a budget surplus, huge reserves, not too high inflation" 1
Finally, the possibilities of the largest corporations to manage the capital structure are maximum, since favorable market conditions, cheap borrowed capital, until some time, significantly reduced not only financial, but also general market risk for them.
3.2 Business size matters
Large Russian business has already lost the opportunity to refinance and build up new foreign debt. In this regard, there has been a significant increase in the number and scope of mergers and acquisitions in the financial sector.
But let's return to the calculation of the effect of financial leverage: the last of the above parameters that determine the effect and strength of the impact of financial leverage is income tax - a factor not controlled by business. It "works" in favor of domestic corporations, because, as the formula shows, the higher the tax rate, the lower the effect of financial leverage. Russia boasts one of the lowest income taxes in the world, the rate of which is 24%. Having gained access to cheap Western loans, the domestic big business "skimmed the cream" also in this direction.
Well, medium and small businesses, involuntarily remaining faithful to the domestic financial market, had to be content with the sources that this market offered. It must be admitted that the flow of "hot" Western money that spilled over into the Russian market contributed to a gradual reduction in the cost of domestic loans for corporations. Banking margins, which peaked in 2004, when the largest banks entered the external debt capital market, gradually decreased, as a result, the price of loans on the domestic market also decreased markedly. It was during that period that the scale of mortgage lending to the population and housing construction grew. Cheaper, though still expensive compared to Western ones, domestic loans still found a use for themselves, working for Russia.
Medium business was looking and finding new ways to get cheaper debt capital. Thus, since 2003, the scale of borrowing through the issuance of corporate bonds by medium-sized companies has been noticeably expanding. Moreover, bonds were often placed by closed subscription, which, as you know, significantly reduces the issuer's costs for issuance. Indeed, the closed way of placing bonds, practiced with a relatively small (but sufficient for medium-sized businesses) issue scale, on the one hand, provides the issuer not only with capital, but also with a good credit history for future possible IPOs, and on the other hand, allows him to receive borrowed capital at a cost below the bank.
Why do private subscription participants settle for low returns? The fact is that those who are interested in the implementation of the invested project are involved in the closed subscription - suppliers of equipment, raw materials, buyers of products, local authorities, who are interested in the emergence of new jobs and the investment attractiveness of their city, district. Ultimately, in addition to profitability, subscription participants receive other benefits: suppliers of raw materials - a reliable market, buyers - a reliable supplier, and local authorities - new jobs, increased tax revenues, etc.
For small businesses, such sources of borrowed capital are practically inaccessible. For those companies that are not included in government programs support for small businesses and did not get access to cheap loans through them, they had to attract expensive bank loans, look for partners with capital, turning them into co-owners, losing their independence, or go into the shadows and develop by reducing tax and extra-budgetary payments.
Does (and to what extent) financial risk affect the formation of financial strategies of Russian business entities of different scale? The minimum financial risk in favorable market conditions was borne by the largest corporations exporting raw materials and low value-added products, which gained access to cheap Western debt markets. But small and medium-sized businesses that borrowed in the domestic, more expensive market, also faced higher financial risk.
The same situation is observed with regard to domestic banks that have not been able to get access to cheap Western loans. Since the rates on interbank loans, although they were declining, but to a lesser extent than for banks of the first (6-7%) and second round (7-8%), medium and small domestic banks had to be content with a lower margin, which was established at the level of 8- nine%. Under the influence of the liquidity crisis, by the end of 2007 the rates on interbank credits rose again by 1.5-2%, less for the first-tier banks and more for the third-tier ones.
No less significant for the subjects of domestic business are other internal factors that affect financial strategies in different ways. Without going into detail here, let's list them:
* the level of the required rate of return, profitability ("appetites" of companies are not the same, respectively, their financial strategies and risks differ);
* cost structure (level operating lever correlates with industry affiliation and depends on the capital intensity of the technologies used);
* industry affiliation of the company, its organizational and legal form, stage life cycle, age, place in the market, etc.
Since in an open economy, and the Russian economy is approaching its standards, the impact of the external environment on the company's activities is large, it can be assumed that external factors also affect the effect of financial leverage in a wider range of areas than internal ones, and, consequently, their influence may turn out to be big. Factors external to business are such factors as the dynamics of the bank margin, the average market value of bank loans and non-bank sources for the corporate sector.
Taking into account the changes in the external environment brought by the state policy to various sectors of the economy, we will expand the list of considered internal and external factors that affect the effect of financial leverage and the strength of its impact. Let us focus on those environmental factors that are regulated by the market and the state.
3.3 Structure of external factors influencing the effect of financial leverage
Indicators of the impact on the financial behavior of the company of external factors that cause an increase or decrease in the effect of financial leverage, we will consider changes in government policy and market conditions that are taking shape in world markets. The influence of market conditions on the world markets for raw materials, metals and other low-added products, as well as on financial markets by the end of 2007 has already been largely considered. We only add that the volatility of the ruble exchange rates and the main currencies used for international settlements also significantly change the financial behavior Russian companies and banks, primarily those with access to foreign markets.
Exchange rate and interest rates
The peculiarity of the current situation is that in the last two years the exchange rate of the US dollar, which is still the main currency of international settlements, has been falling against the ruble and a number of other national currencies, but primarily against the euro. Although the exchange rate of the ruble against the European currency is declining, in the last 3-4 years the rate of this decline has slowed down, forcing large exporters, including Russian ones, to switch to the euro.
As is known, the dependence of the national currency rate on the inflation rate is especially high in countries with a large volume of international exchange of goods, services and capital, and the relationship between the dynamics of currencies and the relative rate of inflation is most clearly manifested when calculating the exchange rate based on export prices. In this regard, both Russia and the United States are approximately in an equal position, with the only exception that Russian oil and gas exports are accompanied by a long and high increase in world prices for these products, which positively affects Russia's balance of payments, while the United States, in conditions of costly and an unsuccessful military operation in the Middle East have a balance of payments deficit.
Just like other exporting countries, Russia uses a wide arsenal of means of regulating international credit relations - these are tax and customs benefits, state guarantees and subsidizing interest rates, subsidies and loans. However, to a greater extent Russian state supports large corporations and banks, as a rule, with a solid state participation, that is, itself. But medium and small businesses get little from the flow of benefits that spills onto large businesses. On the contrary, loans for the purchase of imported equipment are provided to small and medium-sized companies that are not included in small business support programs on conditions that are significantly more stringent than for large businesses.
The exchange rate and the direction of movement of world capital are also affected by the difference in interest rates in different countries. An increase in interest rates stimulates the inflow of foreign capital into the country and vice versa, and the movement of speculative, "hot" money increases the instability of the balance of payments. But it is unlikely that the regulation of interest rates is productive due to the need to control liquidity, which means that it can hinder economic growth. At the same time, the Central Bank reduced the rate of deductions to the Mandatory Reserve Fund for ruble deposits. This measure is justified by the fact that reserve requirements are lower in Europe, and Russian banks find themselves in unequal conditions.
Conclusion
In general, the above allows us to draw the following conclusions.
1. External and internal factors in relation to business affect the effect of financial leverage and the strength of its impact, and this affects the financial behavior of domestic companies and banks of various sizes in different ways.
2. External factors related to government regulation of certain areas of business activity (taxation, dynamics of the cost of bank loans, government financing of business support programs, etc.), as well as market influence (bond and stock yields, price dynamics in the world market, exchange rate dynamics currencies, etc.) have a stronger influence on the effect of financial leverage than internal factors controlled by the business itself.
3. An assessment of the degree of influence of external factors, primarily state regulation, on the financial behavior of business entities of various sizes shows that it is focused on supporting, first of all, banks and large businesses, sometimes to the detriment of the interests of medium and small businesses.
4. A feature of large Russian business, which makes maximum use of the effect of financial leverage in its financial strategies, is the significant participation of the state in these largest corporations and banks. Thus, for the latter, state regulation is not absolutely external factor.
5. Really deals with the management of the capital structure in a changing external environment and, due to its capabilities, only business in which the state does not participate, that is, medium and small companies. The state does this for big business, creating the most favored nation treatment for it.
6. Management of the capital structure and the formation of appropriate financial strategies by medium and small businesses pushes them beyond the legal field, since the Russian financial market today is built and adjusted to the interests of large business with state participation.
7. The global liquidity crisis, in which the Russian economy is also involved through large-scale loans to large businesses in the external financial market, may further weaken the financial capabilities of medium and small businesses and lead to mass bankruptcies of enterprises in these categories, while large businesses will be protected by the state .
Summing up, it should be noted that such a concept as accounts payable cannot be given an unambiguous assessment. Borrowed funds are necessary for the development of the enterprise. However, illiterate management can lead to an increase in debt and the inability to pay off debts. On the other hand, with skillful management, with the help of borrowed funds, you can save and increase your own funds. Therefore, borrowing money can be both beneficial and harmful.
Bibliography
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2. Rumyantseva E.E. Financial management: textbook / E.E. Rumyantsev. - M. : RAGS, 2009. - 304 p.
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7. Surovtsev M.E. Financial management: workshop; textbook allowance / M.E. Surovtsev, L.V. Voronova. - M.: Eksmo, 2009. - 140 p. - (Higher economic education)
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Based on data tables 11 calculate the effect of financial leverage.
The effect of financial leverage (E fr) is an indicator that determines how much the percentage increases the return on equity (R sk) by attracting borrowed funds (LC) into the turnover of the enterprise. The effect of financial leverage occurs when the economic return on capital is higher than the interest on the loan.
|
E fr \u003d [R ik (1 - K n) - C pk] | ||
E fk - the effect of financial leverage
R ik - return on invested capital before taxes (SP: SIK)
K n - taxation coefficient (Staxes:SP)
C pc - the interest rate on the loan provided for by the agreement
ZK - borrowed capital
SK - equity
Thus, the effect of financial leverage includes two components:
The difference between the return on invested capital after tax and the rate for loans:
R ik (1 - K n) - S pk
Financial Leverage:
Positive Efr occurs if R ik (1 - K n) - C pc > 0
If R IK (1 - K N) - C pc< 0, то создается отрицательный Э ФР (эффект «дубинки»), в результате чего происходит «проедание» собственного капитала и последствия могут быть резко негативными для предприятия. В этом случае рискованно увеличивать плечо финансового рычага, т.е. долю заемного капитала.
The effect of financial leverage depends on three factors:
a) the difference between the total return on invested capital after tax and the contractual interest rate:
R IK (1-K N) - C pk \u003d +, - ...%
b) reduction in the interest rate adjusted for tax benefits (tax savings):
C pc \u003d C pc (1 - K N) \u003d + ...%
c) financial leverage:
ZK: SK = ... %
Based on the results of factor analysis, draw a conclusion about the degree of influence of each factor; whether it is profitable for the enterprise in the current conditions to use borrowed funds in the turnover of the enterprise, whether as a result of this the return on equity increases. It should be borne in mind that by attracting borrowed funds, the enterprise can achieve its goals faster and on a larger scale, it takes an economically justified risk.
Liquidity analysis and solvency assessment.
The liquidity of an economic entity is its ability to quickly repay its debt. You can quickly determine the liquidity of an economic entity using the absolute liquidity ratio.
Solvency of the enterprise - the ability to cash resources in a timely manner to repay their payment obligations. Solvency analysis is necessary both for the enterprise (assessment and forecast of financial activity) and for external investors (banks), which, before issuing a loan, must verify the creditworthiness of the borrower. This also applies to those enterprises that want to enter into economic relations with each other.
Solvency assessment is carried out on the basis of the characteristics of the liquidity of current assets, which is determined by the time required to convert them into cash. The less time it takes to collect a given asset, the higher its liquidity.
Balance sheet liquidity is the ability of an enterprise to turn assets into cash and pay off its payment obligations (the degree of coverage of the enterprise's debt obligations by its assets, the term for converting them into cash corresponds to the maturity of payment obligations). The liquidity of the balance sheet depends on the extent to which the value of available means of payment corresponds to the value of short-term debt obligations. The solvency of the enterprise depends on the degree of liquidity of the balance sheet, while it may be solvent at the reporting date, but have unfavorable opportunities in the future.
The liquidity analysis of the balance sheet consists in comparing the funds of the asset (grouped by the degree of decreasing liquidity) with short-term liabilities of the liability (grouped by the degree of increasing maturity). Carry out the appropriate grouping in table 12.
Depending on the degree of liquidity, the assets of an economic entity are divided into the following groups:
A 1 - the most liquid assets
(cash and short-term financial investments);
A 2 - fast-selling assets
(accounts receivable, VAT, other current assets);
A 3 - slow-moving assets
(stocks, excluding future expenses; long-term financial investments);
A 4 - hard-to-sell assets
(intangible assets, fixed assets, construction in progress, other non-current assets, deferred expenses).
Liabilities of the balance are grouped according to the degree of urgency of their payment:
P 1 - the most urgent liabilities
(accounts payable);
P 2 - short-term liabilities
(without accounts payable, i.e. borrowed funds, dividend payments, deferred income, reserves for future expenses, other short-term liabilities);
P 3 - long-term liabilities
(long-term borrowings and other long-term liabilities);
P 4 - permanent liabilities
(capital and reserves)
The balance is considered absolutely liquid if the following conditions are met:
A 1 ³P 1 A 3³P 3
A 2 ³P 2 A 4 £ P 4
The liquidity of an economic entity can be quickly determined using the absolute liquidity ratio, which is the ratio of cash ready for payments and settlements to short-term liabilities. This coefficient characterizes the ability of an economic entity to mobilize funds to cover short-term debt. The higher this ratio, the more reliable the borrower.
Assessment of the balance sheet structure
and diagnostics of the risk of bankruptcy of the enterprise
As criteria for diagnosing the risk of bankruptcy, indicators of assessing the structure of the balance sheet are used. For the purpose of recognizing agricultural organizations as insolvent, the structure of the balance sheet for the last reporting period is analyzed ( table 13):
Current liquidity ratio (K TL);
The coefficient of security with own working capital (K OSS);
The coefficient of restoration (loss) of solvency (K V (U) P).
The balance sheet structure is recognized as unsatisfactory, and the organization is insolvent, if one of the following conditions is present:
To TL at the end of the reporting period has a value of less than 2.
To OSOS at the end of the reporting period is less than 0.1.
According to the organization's balance sheet, the current liquidity ratio (K TL) is determined as the ratio of the actual value of those available to the enterprise (organization) working capital in the form of inventories, finished products, cash, receivables and other current assets (section II of the balance sheet asset) (TA) to the most urgent liabilities of the enterprise in the form of short-term bank loans, short-term loans and payables (TP):
K 1 \u003d Current Assets (without deferred expenses): Current Liabilities (without deferred income and reserves for future expenses and payments), where
TA - total for section II "Current assets";
TP - total for section V "Current liabilities"
The coefficient of provision with own working capital (K OSS) is determined by:
K 2 \u003d Availability of own sources (III P - I A): The amount of working capital (II A), where
III P p. 490 - total for section III "Capital and reserves";
I A p. 190 - total for section I "Non-current assets";
II A p. 290 - total for section II "Current assets";
In the event that the current liquidity ratio and the ratio of own working capital (at least one) are below the normative values, then the balance sheet structure is assessed as unsatisfactory and then the solvency recovery ratio is calculated for a period equal to 6 months.
In the event that both ratios meet or exceed the standard level: current liquidity ratio ≥ 2 and working capital ratio ≥ 0.1, then the balance sheet structure is assessed as satisfactory and then the solvency loss ratio is calculated for a period equal to 3 months.
The coefficient of recovery (loss) of solvency (K V (U) P) is determined taking into account the current liquidity ratios calculated according to the data at the beginning and at the end of the year:
KZ \u003d [K tl. end of the year + (U: T) (K tl. end of the year - K tl beginning of the year)] : K standard. , where
To tl.end of the year - the actual value of the current liquidity ratio, calculated according to the balance sheet at the end of the year;
To tl the beginning of the year - the value of the current liquidity ratio, calculated according to the balance sheet at the beginning of the year;
To the standard. – normative value equal to 2;
T - reporting period equal to 12 months;
At – solvency recovery period equal to 6 months. (loss of solvency - 3 months).
The coefficient of loss of solvency, which takes a value of less than 1, indicates that the organization will lose its solvency in the near future. If the solvency loss ratio is greater than 1, then there is no threat of bankruptcy in the next 3 months.
Conclusions about the recognition of the balance sheet structure as unsatisfactory, and the enterprise as insolvent, are made with a negative balance sheet structure and the absence of a real opportunity for it to restore its solvency.
In the process of subsequent analysis, ways to improve the structure of the balance sheet of the enterprise and its solvency should be studied.
First of all, you should study the dynamics of the balance sheet currency. The absolute decrease in the balance sheet indicates a reduction in the economic turnover of the enterprise, which is one of the reasons for its insolvency.
Establishing the fact of curtailment of economic activity requires a thorough analysis of its causes. Such reasons may be a reduction in effective demand for the products and services of this enterprise, limited access to raw materials markets, the gradual inclusion of subsidiaries in the active economic turnover at the expense of the parent company, etc.
Depending on the circumstances that caused the reduction in the economic turnover of the enterprise, various ways can be recommended to bring it out of a state of insolvency.
With an increase in the balance sheet for the reporting period, one should take into account the impact of the revaluation of funds, the rise in the cost of inventories, finished products. Without this, it is difficult to conclude whether the increase in the balance sheet is a consequence of the expansion of the economic activity of the enterprise or a consequence of inflationary processes.
If an enterprise expands its activities, then the reasons for its insolvency should be sought in the irrational use of profits, the diversion of funds into accounts receivable, the freezing of funds in excess production reserves, errors in determining pricing policy etc.
Study of the structure of the balance sheet liability allows you to establish one of the possible reasons for the insolvency of the enterprise - too a high proportion borrowed funds in the sources of financing of economic activity. The trend of increasing the share of borrowed funds, on the one hand, indicates an increase in the financial stability of the enterprise and an increase in the degree of its financial risk, and on the other hand, an active redistribution of income in the context of inflation in favor of the borrowing enterprise.
The assets of the enterprise and their structure are studied both in terms of their participation in production and in terms of their liquidity. A change in the structure of assets in favor of an increase in working capital indicates:
on the formation of a more mobile structure of assets, contributing to the acceleration of the turnover of the company's funds;
on the diversion of a part of current assets for lending to buyers, subsidiaries and other debtors, which indicates the actual immobilization of working capital from the production process;
on the curtailment of the production base;
on the delayed adjustment of the value of fixed assets in the face of inflation.
If there are long- and short-term financial investments, it is necessary to assess their effectiveness and liquidity of securities in the company's portfolio.
The absolute and relative growth of current assets may indicate not only the expansion of production or the impact of the inflation factor, but also a slowdown in capital turnover, which causes the need to increase its mass. Therefore, it is necessary to study the indicators of turnover of working capital in general and at individual stages of the cycle.
When studying the structure of inventories and costs, it is necessary to identify trends in changes in inventories, work in progress, finished products and goods.
An increase in the share of inventories may be the result of:
increasing the production capacity of the enterprise;
the desire to protect funds from depreciation in conditions of inflation;
irrationally chosen economic strategy, as a result of which a significant part of working capital is frozen in stocks, the liquidity of which may be low.
When studying the structure of current assets, much attention is paid to the state of settlements with debtors. The high growth rates of receivables indicate that this company is actively using the strategy of commodity loans for consumers of its products. By lending to them, the company actually shares with them part of its income. At the same time, if payments for products are delayed, the company is forced to take out loans to support its activities, increasing its own financial obligations to creditors. Therefore, the main task of a retrospective analysis of accounts receivable is to assess its liquidity, i.e. repayment of debts to the enterprise, for which it is necessary to decipher it with information about each debtor, the amount of debt, the prescription of formation and the expected repayment periods. It is also necessary to estimate the rate of capital turnover in receivables and cash, comparing it with the rate of inflation.
A necessary element of the analysis of the financial condition of insolvent enterprises is the study of financial performance and the use of profits. If the enterprise is unprofitable, then this indicates the absence of a source of replenishment of own funds and the “eating away” of capital. The ratio of the amount of own capital to the amount of losses of the enterprise shows the speed of its "eating up".
In the event that the company makes a profit and is at the same time insolvent, it is necessary to analyze the use of profits. It is also necessary to study the possibilities of the enterprise to increase the amount of profit by increasing the volume of production and sales of products, reducing its cost, improving quality and competitiveness. Great help in identifying these reserves and can provide an analysis of the performance of enterprises - competitors.
One of the reasons for the insolvency of economic objects is the high level of taxation, therefore, in the analysis, it is advisable to calculate the tax burden of the enterprise.
A decrease in the amount of equity capital can also occur due to the negative effect of financial leverage, when the profit received from the use of borrowed funds is less than the amount of financial costs of debt servicing.
Based on the results of the analysis, specific measures should be taken to improve the structure of the balance sheet and the financial condition of insolvent business entities.
The effect of financial leverage this is an indicator that reflects the change in the return on equity obtained through the use of borrowed funds and is calculated using the following formula:
Where,
DFL - effect of financial leverage, in percent;
t - income tax rate, in relative terms;
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 allows you 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 reverse side of financial leverage) occurs when the return on assets falls below the loan rate, which leads to accelerated loss formation.
Incidentally, the common theory is that the US mortgage crisis was a manifestation of the negative effect of financial leverage. When the program of non-standard mortgage lending was launched, interest rates on loans were low, while real estate prices were growing. The low-income strata of the population were involved in financial speculation, since almost the only way for them to repay the loan was the sale of housing that had risen in price. When housing prices crept down, and loan rates rose due to increasing risks (the leverage began to generate losses, not profits), the pyramid collapsed.
Components effect of financial leverage are shown in the figure below:
As can be seen from the figure, the effect of financial leverage (DFL) is the product of two components, adjusted by the tax coefficient (1 - t), which shows the extent to which the effect of financial leverage is manifested due to different levels of income tax.
One of the main components of the formula is the so-called financial leverage differential (Dif) or the difference between the return on the company's assets (economic profitability), calculated on EBIT, and the interest rate on borrowed capital:
Dif = ROA - r
Where,
r - interest rate on borrowed capital, in %;
ROA - return on assets (economic return on EBIT) in%.
The financial leverage differential is the main condition that forms the growth of return on equity. For this, it is necessary that the economic profitability exceed the interest rate of payments for the use of borrowed sources of financing, i.e. the financial 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 coefficient of financial leverage (shoulder of financial 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 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 own 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 obtaining a negative differential.
According to economists, based on a study of the empirical material of successful foreign companies, the optimal effect of financial leverage is within 30-50% of the level of economic return on assets (ROA) with a financial leverage of 0.67-0.54. In this case, an increase in the return on equity is ensured not lower than the increase in the profitability of investments in assets.
The effect of financial leverage contributes to the formation of a rational structure of the sources of funds of the enterprise in order to finance the necessary investments and obtain the desired level of return on equity, in which the financial stability of the enterprise is not violated.
Using the above formula, we will calculate the effect of financial leverage.
| Indicators | Ed. rev. | Value |
|---|---|---|
| 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 income | 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% |
| Effect of financial leverage (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 loss of financial stability. The higher the share of borrowed capital, the higher the sensitivity of net income to changes in balance sheet profit. Thus, with additional borrowing, the return on equity may increase, provided:
if ROA > i, then ROE > ROA and ΔROE = (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, at the same time, it is necessary to monitor the differential (ROA - i), since with an increase in the leverage of financial leverage (D / E), lenders tend to compensate for their risk by increasing the 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 optimally be equal to 30 - 50% of the return on assets, since the stronger the effect of financial leverage, the higher the financial risk of loan default, falling dividends and share prices.
The level of associated risk characterizes the operational and financial leverage. Operating and financial leverage, along with the positive effect of increasing the return on assets and equity as a result of growth in sales and borrowings, also reflects the risk of lower profitability and incurring losses.
Consider the financial leverage of an enterprise, the economic meaning, the formula for calculating the effect of financial leverage and an example of its assessment for JSC RusHydro.
Financial leverage of the enterprise (analogue: leverage, credit leverage, financial leverage, leverage) - shows how the use of borrowed capital of the enterprise affects the amount of net profit. Financial leverage is one of key concepts financial and investment analysis of the enterprise. In physics, leverage allows you to lift more weight with less effort. A similar principle of action in the economy for financial leverage, which allows you to increase profits with less effort.
The purpose of using financial leverage is to increase the profit of the enterprise by changing the structure of capital: the shares 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 the increase in the financial risk of the enterprise, the possibility of obtaining greater profits also increases.
financial leverage. economic sense
The effect of financial leverage is explained by the fact that attracting additional funds makes it possible to increase the efficiency of the production and economic activities of the enterprise. After all, the attracted capital can be directed to the creation of new assets that will increase both the 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 company's owners.
The effect of financial leverage. Calculation formula
The effect of financial leverage is the product of the differential (with tax corrector) times the lever arm. The figure below shows a diagram of the key links in the formation of the effect of financial leverage.
If you write down the three indicators included in the formula, then it will look like this:
T is the percentage rate of income tax;
ROA - return on assets of the enterprise;
r – interest rate on attracted (borrowed) capital;
D - borrowed capital of the enterprise;
E - equity capital of the enterprise.
So, let's analyze in more detail each of the elements of the effect of financial leverage.
tax corrector
The tax corrector shows how a change in the income tax rate affects the effect of financial leverage. Everyone 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 engaged 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
The financial leverage differential (Dif) is the difference between the return on assets and the rate on borrowed capital. In order for the effect of financial leverage to be positive, it is necessary that the return on equity be higher than interest on loans and borrowings. With a negative financial leverage, the enterprise begins to suffer losses, because it cannot provide production efficiency higher than the payment for borrowed capital.
Financial leverage ratio (analogue: financial leverage) shows what share in the total capital structure of the enterprise is occupied by borrowed funds (credits, loans, and other obligations), and determines the strength of the influence of borrowed capital on the effect of financial leverage.
Optimal leverage for the effect of financial leverage
On the basis of empirical data, the optimal leverage (debt-to-equity ratio) for an enterprise 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 losing financial independence, solvency and the risk of bankruptcy. If the amount of borrowed capital is less than 50%, the company misses the opportunity to increase profits. Optimal size 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 return on equity ( ROA, Return on Assets) over return on equity ( ROE, Return on Equity). Return on equity (ROA) shows the profitability of the company's use of both equity and debt capital, while ROE reflects only the effectiveness of equity. The calculation formula will look like this:
where:
DFL - effect of financial leverage;
ROA - return on capital (assets) of the enterprise;
ROE - return on equity
Let us calculate the effect of financial leverage for JSC RusHydro on the balance sheet. To do this, we calculate the profitability ratios, the formulas of which are presented below:
Calculation of the return on assets (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.
The income statement is 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 operations 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 the 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 improves the competitiveness of the enterprise. Illiterate management of borrowed capital can lead to a rapid increase in insolvency and the risk of bankruptcy.
