Financial leverage and methods for determining it. Financial leverage of the enterprise. Formula and calculation using the example of JSC RusHydro

Reasons for attracting debt capital: the company has good (in the opinion of its owners and top managers) opportunities to implement a certain project, but does not have sufficient own sources of financing. Profit, as the most accessible source of own funds, is limited; borrowed capital in the banking services market is not limited. Very often, profits are dispersed across different assets and therefore profits cannot be used directly for financing transactions.
During mobilization debt capital real money arises at a time and in large amounts.

Raising debt capital to enhance the economic potential of an enterprise requires proper justification.
EGF = (ROA - Tsk) x (1 - Kn) x ZK/SK, where ROA is the economic profitability of total capital before taxes (the ratio of the amount of book profit to the average annual amount of total capital), %;
Tsk - weighted average price of borrowed resources (ratio of costs for servicing debt obligations to the average annual amount of borrowed funds), %;
Кн - taxation coefficient (the ratio of the amount of taxes from profit to the amount of balance sheet profit) in the form of a decimal fraction;
ZK - average annual amount of borrowed capital;
SK is the average annual amount of equity capital.

The effect of financial leverage shows by what percentage the amount of equity capital increases due to the attraction of borrowed funds into the turnover of the enterprise. Positive effect of financial leverage occurs in cases where the return on total capital is higher than the weighted average price of borrowed resources, i.e. if ROA > Tsk. For example, the after-tax return on total equity is 15%, while the cost of debt is 10%. The difference between the cost of borrowed funds and the return on total capital will increase the return on equity. Under such conditions, it is beneficial to increase financial leverage, i.e. share of borrowed capital. If ROA is negative, the effect of financial leverage (the “stick” effect), resulting in a depreciation of equity capital, which may cause bankruptcy of the enterprise.

In conditions of inflation, if debts and interest on them are not indexed, the EFR and return on equity(ROE) increase because debt service and the debt itself are paid for with already depreciated money.
Then the effect of financial leverage will be equal to: EGF = x (1 - Kn) x ZK/SK + (I x ZK)/SK x 100%, where I is the inflation rate as a decimal fraction.

Attracting borrowed funds changes the structure of sources, increases the financial dependence of the company, increases the financial risk associated with it, and leads to an increase in WACC. This explains the importance of such a characteristic as financial leverage.

The essence, significance and effect of financial leverage:

• a high share of borrowed capital in the total amount of financing sources is characterized as a high level of financial leverage and indicates a high level of financial risk;
• financial leverage indicates the presence and degree of financial dependence of the company on landers;
• attracting long-term loans and borrowings is accompanied by an increase in financial leverage and, accordingly, financial risk;
• the essence of financial risk is that regular payments (for example, interest) are mandatory, therefore, if the source is insufficient, and this is earnings before interest and taxes, it may be necessary to liquidate part of the assets;
• for a company with a high level of financial leverage, even a small change in earnings before interest and taxes due to known restrictions on its use (first of all, the requirements of landers, i.e. third-party suppliers of financial resources, are satisfied, and only then - the owners of the enterprise) can lead to a significant change in net profit.

Theoretically, financial leverage can be equal to zero - this means that the company finances its activities only from its own funds, i.e. capital provided by owners and profits generated; such a company is often called a financially independent (unlevered company). In the event that borrowed capital is raised (bond issue, long-term loan), the company is considered as a financially dependent company.
Measures of financial leverage:

• debt/equity ratio;
• the ratio of the rate of change in net profit to the rate of change in gross profit.

The first indicator is very clear, easy to calculate and interpret, the second is used to quantify the consequences of the development of the financial and economic situation (production volume, product sales, forced or targeted changes in pricing policy, etc.) under the conditions of the chosen capital structure, i.e. . selected level of financial leverage.

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 methods and scope of application in making 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 financial leverage effect and calculation methods

1.1 The first method of calculating financial leverage

1.2 The second method of calculating financial leverage

1.3 The third method of calculating financial leverage

2. The combined effect of operating and financial leverage

3. The power of financial leverage in Russia

3.1 Controllable factors

3.2 Business size matters

3.3 Structure of external factors affecting the effect of financial leverage

Conclusion

Bibliography

Introduction

Profit is the simplest and at the same time the most complex economic category. It received new content in the conditions of modern economic development of the country, the formation of real independence of business entities. Being the main driving force of a market economy, it ensures the interests of the state, owners and personnel of the enterprise. Therefore, one of the urgent tasks of the modern stage is the mastery by executives and financial managers of modern methods of effective management of profit generation 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. The priority is the rule that both own and borrowed funds must provide a return in the form of profit. Competent, effective management of profit generation involves the construction at the enterprise of appropriate organizational and methodological systems for ensuring this management, knowledge of the basic mechanisms of profit generation, and the use of modern methods of its analysis and planning. One of the main mechanisms for achieving this task is financial leverage.

The purpose of this work is to study the essence of the financial leverage effect.

The tasks include:

· consider the financial and economic content

· consider calculation methods

· consider the scope of application

1. The essence of the financial leverage effect and calculation methods

Managing profit generation involves the use of appropriate organizational and methodological systems, knowledge of the basic mechanisms of profit generation 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 circulation period of the securities. The costs associated with debt servicing 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 considered a business expense (operating expense), using debt as a source of financing is less expensive for a business than other sources that are paid out of net income (for example, stock dividends). 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 influence on the profit of the enterprise. One of the main mechanisms for achieving this goal is financial leverage.

Financial leverage) characterizes the use of borrowed funds by an enterprise, which affects the value of return on equity. Financial leverage is an objective factor that arises with the appearance of borrowed funds in the amount of capital used by an enterprise, allowing it to obtain additional profit on its own capital.

The idea of ​​financial leverage American concept consists in assessing the level of risk based on fluctuations in net profit caused by the constant value of the enterprise’s costs of servicing debt. Its effect is manifested in the fact that any change in operating profit (earnings before interest and taxes) generates a more significant change in net profit. Quantitatively, this dependence is characterized by the indicator of the strength of influence of financial leverage (SVFR):

Interpretation of the leverage ratio: it shows how many times earnings before interest and taxes exceed net income. The lower limit of the coefficient is unity. The greater the relative volume of borrowed funds attracted by an enterprise, the greater the amount of interest paid on them, the higher the power of financial leverage, and 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 power of financial leverage, ceteris paribus, leads to greater financial instability, expressed in less predictability of net profit. Since the payment of interest, unlike, for example, the payment of dividends, is mandatory, then with a relatively high level of financial leverage, even a slight decrease in the profit received can have unfavorable consequences compared to a situation where the level of financial leverage is low.

The higher the impact of financial leverage, the more non-linear the relationship between net profit and profit before interest and taxes becomes. A small 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.

An 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. For two enterprises with the same production volume, but different levels of financial leverage, the variation in net profit due to changes in production volume is not the same - it is greater for the enterprise with a higher 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 capital at different proportions of the use of borrowed funds. This method of calculation is widely used in the countries of continental Europe (France, Germany, etc.).

Financial leverage effect(EFF) shows by what percentage the return on equity capital increases due to the attraction of borrowed funds into the turnover of the enterprise and is calculated using the formula:

EGF =(1-Np)*(Ra-Tszk)*ZK/SK

where N p is the income tax rate, in fractions of units;

Рп - 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 зк - weighted average price of borrowed capital, in fractions of units;

ZK - average annual cost of borrowed capital; SC - average annual cost of equity capital.

The above formula for calculating the effect of financial leverage has three components:

♦ tax corrector of financial leverage(l-Нп), which shows to what extent the effect of financial leverage is manifested in connection with different levels of profit taxation;

♦ leverage differential(p a -Ts, k), characterizing 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 enterprise's equity capital. In conditions of inflation, the formation of the effect of financial leverage is proposed to be considered depending on the inflation rate. If the amount of debt of the enterprise and interest on loans and borrowings are not indexed, the effect of financial leverage increases, since debt servicing and the debt itself are paid with already depreciated money:

EGF=((1-Np)*(Ra – Tsk/1+i)*ZK/SK,

where i is a 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 differentiated tax rates are established for various types of activity of the enterprise;

♦ if the enterprise uses income tax benefits for certain types of activities;

♦ if individual subsidiaries of the enterprise operate in free economic zones of their country, where preferential income taxation regimes apply, as well as in foreign countries.

In these cases, by influencing the sectoral or regional structure of production and, accordingly, the composition of profit according to the level of its taxation, it is possible, by reducing the average rate of profit taxation, to reduce the impact of the tax adjustment of financial leverage on its effect (all other things being equal).

The financial leverage differential is a condition for the occurrence of the financial leverage effect. Positive EFR occurs in cases where the return on total capital (Ra) exceeds the weighted average price of borrowed resources (TZK)

Financial leverage(or leverage) is a method of influencing an organization’s profit performance by varying the volume and composition of long-term liabilities.

Financial leverage just reveals the essence of this phenomenon, since “leverage” is translated from English as “a device for lifting weights.”

The effect of financial leverage shows, is it really necessary to attract borrowed funds at the moment, because an increase in their share in the structure of liabilities will lead to an increase in the return on equity capital.

What does financial leverage consist of?

To calculate the impact that financial leverage has, an economic formula is used, which is based on three components:

• Tax proofreader. Characterizes a change in the effect of financial leverage with a simultaneous increase in the volume of the tax burden. This indicator does not depend on the activity of the enterprise, since tax rates are regulated by the state, but the company’s financiers can play on changes in the tax adjuster if subsidiaries apply different tax policies depending on the territory or type of activity.
• Financial leverage ratio. Another parameter of financial leverage is calculated by dividing borrowed funds by equity. Accordingly, it is this ratio that shows whether financial leverage will have a positive impact on the company’s activities, depending on what the resulting ratio is.
• Financial leverage differential. The final measure of leverage can be obtained by subtracting the average interest paid on all loans from the return on assets ratio. The greater the value of this component, the more likely the possibility of a positive impact of financial leverage on the organization. By constantly recalculating this indicator, financiers can monitor the moment at which the return on assets begins to decline and intervene in the current situation in a timely manner.

The sum of all three components will show the volume of funds raised from outside that is necessary to obtain the required increase in profit.

How is financial leverage calculated? Calculation formula

Let's look at three ways to assess the impact of financial leverage(or leverage):

1. The first method is the most common. Here the effect is calculated according to the following scheme: the difference between the unit and the tax rate in fractional terms is multiplied by the difference in the return on assets ratio as a percentage and the average interest on loans paid. The resulting amount is multiplied by the ratio of borrowed and equity funds. Literally, the formula looks like this:

EFL = (1- SNP) x (KVRa – PC) x ZS/SS.

Thus, three options are possible the impact of financial leverage on the organization’s activities:

• positive effect— KVR is higher than the average lending rate;
• zero effect— return on assets and rate are equal;
• negative effect, if the average interest rate on loans is lower than the CVR.

1. The second method is built on the same principle as the operating lever. The influence of financial leverage is described here through the rate of increase or decrease in net profit and the rate of change in gross profit. To obtain the value of the strength of financial leverage, the first indicator is divided by the second. This value will show how much profit after taxes and contributions depends on gross profit.
2. Another way to determine the impact of financial leverage is the ratio of the percentage changes in net profit for each ordinary share due to a change in the net result of operating the investment.

Net result of investment exploitation is one of the indicators of a company’s financial performance, which is used in financial management abroad. In simple terms, this is earnings before taxes, fees and interest, or operating profit.

The third method determines the effect of financial leverage by determining the amount of interest by which the organization's net profit per non-preferred share will increase or decrease if operating profit changes by one percent.

Financial dependency ratio. How to calculate?

The financial dependence ratio (FCC) shows whether the company is dependent on external sources of financing and, if so, how dependent. In addition, the ratio helps to see the capital structure as a whole, that is, both debt and equity.

The coefficient is calculated using the following formula:

Financial dependence ratio = Sum of short-term and long-term liabilities / Sum of assets

After calculation under normal conditions, the coefficient is in the range of 0.5 ÷ 0.7. What does it mean:

• Kfz = 0,5. This is the best result in which liabilities are equal to assets, and the financial stability of the company is high.
• Kfz is equal to the value 0.6 ÷ 0.7. This is still an acceptable range of values ​​for the financial dependence ratio.
• Kfz< 0,5. Such values ​​indicate the untapped capabilities of the company due to the fact that it is afraid to attract loans, thus increasing the profitability of its capital.
• Kfz > 0.7. The financial stability of the company is weak because it is overly dependent on external loans.

The effect of financial leverage. Effect calculation

Financial leverage, or rather the effect of its influence, determines by what amount the percentage of profitability of the enterprise’s own assets will increase if funds are raised from outside.

Impact of financial leverage is the difference between the company's total assets and all loans.

Formula for calculating the effect of financial leverage has already been presented above. It includes indicators of the tax rate (TP), return on assets (Rakt), weighted average price of borrowed capital (CZS), cost of borrowed capital (LC) and equity capital (CC) means and looks like this:

EFL = (1- NP) x (Rakt – Zs) x ZS/SS.

The EFL value should be in the range from 0.33 to 0.5.

Financial leverage and profitability

The relationship between the concepts of “financial leverage” and “organizational profitability”, or more precisely, “return on equity capital”, has already been described previously.

To increase the profitability of its own funds, the company needs not only to attract, but also to properly manage borrowed capital. And how successfully the management of the enterprise does this will show the effect of financial leverage.

Leverage ratio

Behind the seemingly complex name lies only the ratio of the amount of borrowed funds and equity. There are several other names for this value, for example, financial leverage or debt ratio (from English “debt ratio”).

Based on the last name, it becomes clear that the ratio reflects the share that funds raised from outside occupy among all sources of the company’s funds.

There is a formula for calculating the financial leverage ratio:

, Where

• D.R.– leverage ratio;
• C.L.- Short-term liabilities;
• LTL- long term duties;
• E.C.- equity;
• L.C.– total raised capital (sum of short-term and long-term borrowed funds).

The normal value of this coefficient is in the range from 0.5 to 0.8.

There are a few things to consider when calculating your leverage ratio:

• When calculating, it would be better to take into account not the accounting data, and the market value of assets. This is due to the fact that large enterprises have a much higher market value of their own funds than their balance sheet value. If you use balance sheet indicators in the calculation, the coefficient will be incorrect.
• Enterprises often have too high a financial leverage ratio, where the largest share of assets is occupied by liquid ones, for example, those of credit and trading organizations. Stable demand and sales guarantee them a stable flow of money, that is, a constant increase in the share of their own funds.

Financial leverage ratio

This indicator allows you to find out what percentage of borrowed capital is in the company's own funds, and, more simply, shows the ratio of the company's borrowed funds and its equity capital.

The coefficient is calculated according to the following formula:

KFR = Net borrowing / Amount of own funds

In other words, net borrowing- These are all the company's liabilities minus its liquid assets.

In this case, equity capital is represented by the amounts on the balance sheet that shareholders invested in the organization: this is the authorized capital or par value of shares, as well as reserves accumulated during the company’s activities.

Retained earnings of the enterprise from its very foundation, the revaluation of property objects is reserve accumulation.

Sometimes The financial leverage ratio can reach critical values:

• Kfr ≥ 100%. This means that the amount of borrowed funds is at least equal to equity, and may even exceed it, which means that creditors bring much larger sums of money to the company than its own shareholders.
• More than 200%. There are known cases when the CFR exceeded 250%. This situation already indicates the complete absorption of the company by its creditors, because most of the sources of funds consist of borrowed funds.

Such situations are not easy to get out of and extreme measures may be taken to reduce the leverage ratio and, consequently, the debt, for example, the sale of several of the company's main activities.

Financial leverage indicator

The essence of the financial leverage indicator is it is a measurement of a firm's financial risk. The leverage becomes longer if the company's share of debt capital increases, and this, in turn, makes the financial condition more unstable and can threaten the company with serious losses.

But, at the same time, an increase in the share of funds raised from outside also increases profitability, only from own funds.

Financial analysis knows two ways to calculate financial leverage indicators(lever):

1. Coverage indicators.

This group of indicators allows you to evaluate, for example, interest coverage on debt payments. With this indicator, gross profit is correlated with the costs of loan payments and they look at how much profit in this case covers the costs.

1. Using loan obligations as a means of financing a company's assets.

The debt ratio, which is calculated by dividing the sum of all liabilities by the sum of all assets, shows how capable the company is of repaying existing loans and obtaining new ones in the future.

A debt ratio that is too high indicates that the company has too little financial flexibility and has small assets with large debts.

Conclusion

So, financial leverage– this is an opportunity for a company to manage its profits by changing the volume and structure of capital, both its own and borrowed.

Entrepreneurs resort to the effect of financial leverage when they plan to increase the company's income.

In this case they attract credit money, replacing their own funds with it.

But we should not forget that an increase in a company’s liabilities always entails an increase in the level of financial risks of the organization.

Any commercial activity involves certain risks. If they are determined by the structure of capital sources, then they belong to the group of financial risks. Their most important characteristic is the ratio of equity to borrowed funds. After all, attracting external financing involves paying interest for its use. Therefore, in the event of negative economic indicators (for example, a decrease in sales volume, personnel problems, etc.), the company may face an unsustainable debt load. At the same time, the price for additionally attracted capital will increase.

Financial occurs when the company uses borrowed funds. A normal situation is when the payment for borrowed capital is less than the profit it brings. When this additional profit is added to the income received from equity, an increase in profitability is observed.

In the commodity and stock markets, financial leverage represents margin requirements, i.e. the ratio of the deposit amount to the total transaction value. This ratio is called leverage.

The financial leverage ratio is directly proportional to the financial risk of the enterprise and reflects the share of borrowed funds in financing. It is calculated as the ratio of the sum of long-term and short-term liabilities to the company's own funds.

Its calculation is necessary to control the structure of sources of funds. The normal value for this indicator is from 0.5 to 0.8. A high value of the ratio can be afforded by companies that have stable and well-predicted dynamics of financial indicators, as well as enterprises with a high share of liquid assets - trading, distribution, banking.

The effectiveness of debt capital largely depends on the return on assets and the lending interest rate. If the profitability is lower than the rate, then it is unprofitable to use borrowed capital.

Calculation of the effect of financial leverage

To determine the correlation between financial leverage and return on equity, an indicator called the financial leverage effect is used. Its essence is that it reflects how much interest equity capital grows when using borrowings.

The effect of financial leverage arises due to the difference between the return on assets and the cost of borrowed funds. To calculate it, a multifactor model is used.

The calculation formula is as follows: DFL = (ROAEBIT-WACLC) * (1-TRP/100) * LC/EC. In this formula, ROAEBIT is the return on assets calculated through earnings before interest and taxes (EBIT), %; WACLC - weighted average cost of borrowed capital, %; EC - average annual amount of equity capital; LC - average annual amount of borrowed capital; RP - profit tax rate, %. The recommended value for this indicator is in the range from 0.33 to 0.5.

For any enterprise, the priority is the rule that both own and borrowed funds must provide a return in the form of profit (income). The effect of financial leverage (leverage) characterizes the feasibility and effectiveness of an enterprise’s use of borrowed funds as a source of financing economic activities.

Financial leverage effect lies in the fact that an enterprise, using borrowed funds, changes the net profitability of its own funds. This effect arises from the discrepancy between the return on assets (property) and the “price” of borrowed capital, i.e. average bank rate. At the same time, the enterprise must provide for such a return on assets that there will be enough funds to pay interest on the loan and pay income taxes.

It should be borne in mind that the average calculated interest rate does not coincide with the interest rate accepted under the terms of the loan agreement. The average settlement rate is determined by the formula:

SP = (FIK: amount of GS) X100,

JV – average calculated rate for a loan;

Fic – actual financial costs for all loans received for the billing period (amount of interest paid);

LC amount – the total amount of borrowed funds raised in the billing period.

The general formula for calculating the effect of financial leverage can be expressed:

EGF = (1 – Ns) X(Ra – SP) X(ZK: SK),

EGF – effect of financial leverage;

NS – profit tax rate in fractions of a unit;

Ra – return on assets;

JV - average calculated interest rate for a loan in%;

ZK - borrowed capital;

SK - equity.

The first component of the effect is tax corrector (1 – Ns), shows to what extent the effect of financial leverage is manifested in connection with different levels of taxation. It does not depend on the activities of the enterprise, since the profit tax rate is approved by law.

In the process of managing financial leverage, a differentiated tax adjuster can be used in cases where:

Differentiated tax rates have been established for various types of enterprise activities;

for certain types of activities, enterprises use income tax benefits;

individual subsidiaries (branches) of the enterprise carry out their activities in free economic zones, both in their own country and abroad.

The second component of the effect is differential (Ra – SP), is the main factor shaping the positive value of the financial leverage effect. Condition: Ra > SP. The higher the positive value of the differential, the more significant, other things being equal, the value of the effect of financial leverage.

Due to the high dynamics of this indicator, it requires systematic monitoring in the management process. The dynamism of the differential is determined by a number of factors:

during a period of deterioration in financial market conditions, the cost of raising borrowed funds may increase sharply and exceed the level of accounting profit generated by the assets of the enterprise;

a decrease in financial stability, in the process of intensively attracting borrowed capital, leads to an increase in the risk of bankruptcy of the enterprise, which forces an increase in interest rates for loans, taking into account the premium for additional risk. The leverage differential can then be reduced to zero or even a negative value. As a result, return on equity will decrease because part of the profit it generates will be used to service the debt received at high interest rates;

during a period of deterioration in the situation on the commodity market, a reduction in sales volume and the amount of accounting profit, a negative differential value can be formed even with stable interest rates due to a decrease in the profitability of assets.

Thus, a negative differential leads to a decrease in the return on equity capital, which makes its use ineffective.

The third component of the effect is debt ratio or financial leverage (ZK: SK) . It is a multiplier that changes the positive or negative value of the differential. With a positive differential, any increase in the debt ratio will lead to an even greater increase in return on equity. If the differential is negative, an increase in the debt ratio will lead to an even greater drop in return on equity.

So, with a stable differential, the debt ratio is the main factor influencing the return on equity capital, i.e. it generates financial risk. Similarly, with a constant debt ratio, a positive or negative differential generates both an increase in the amount and level of return on equity and the financial risk of loss.

By combining the three components of the effect (tax adjuster, differential and debt ratio), we obtain the value of the financial leverage effect. This calculation method allows the company to determine the safe amount of borrowed funds, that is, acceptable lending conditions.

To realize these favorable opportunities, it is necessary to establish the existence of a relationship and contradiction between the differential and the debt ratio. The fact is that with an increase in the volume of borrowed funds, the financial costs of servicing the debt increase, which, in turn, leads to a decrease in the positive value of the differential (with a constant return on equity capital).

From the above, we can do the following conclusions:

if new borrowing brings the enterprise an increase in the level of financial leverage effect, then it is beneficial for the enterprise. At the same time, it is necessary to control the state of the differential, since with an increase in the debt ratio, a commercial bank is forced to compensate for the increase in credit risk by increasing the “price” of borrowed funds;

The lender's risk is expressed by the value of the differential, because the higher the differential, the lower the bank's credit risk. Conversely, if the differential becomes less than zero, then the effect of leverage will act to the detriment of the enterprise, that is, there will be a deduction from the return on equity, and investors will not be willing to buy shares of the issuing company with a negative differential.

Thus, the debt of an enterprise to a commercial bank is neither good nor bad, but it is its financial risk. By attracting borrowed funds, an enterprise can more successfully fulfill its tasks if it invests them in highly profitable assets or real investment projects with a quick return on investment.

The main task for a financial manager is not to eliminate all risks, but to accept reasonable, pre-calculated risks, within the limits of a positive differential. This rule is also important for the bank, because a borrower with a negative differential creates distrust.

Financial leverage is a mechanism that a financial manager can master only if he has accurate information about the profitability of the enterprise’s assets. Otherwise, it is advisable for him to handle the debt ratio very carefully, weighing the consequences of new borrowings in the loan capital market.

The second way to calculate the effect of financial leverage can be considered as a percentage (index) change in net profit for each ordinary share, and the fluctuation in gross profit caused by this percentage change. In other words, the effect of financial leverage is determined by the following formula:

leverage = percentage change in net earnings per common share: percentage change in gross earnings per common share.

The lower the power of financial leverage, the lower the financial risk associated with a given enterprise. If borrowed funds are not involved in circulation, then the power of financial leverage is equal to 1.

The greater the power of financial leverage, the higher the company’s level of financial risk in this case:

for a commercial bank, the risk of non-repayment of the loan and interest on it increases;

For an investor, the risk of a reduction in dividends on his shares of an issuing enterprise with a high level of financial risk increases.

The second method of measuring the effect of financial leverage makes it possible to perform a related calculation of the strength of the impact of financial leverage and establish the cumulative (total) risk associated with the enterprise.

In conditions of inflation, If the debt and its interest are not indexed, the effect of financial leverage increases, since debt service and the debt itself are paid with already depreciated money. It follows that in an inflationary environment, even with a negative value of the financial leverage differential, the effect of the latter can be positive due to the non-indexation of debt obligations, which creates additional income from the use of borrowed funds and increases the amount of equity capital.