leverage effect has the components:
- differential, which is determined by the difference between the return on assets and the average estimated interest on the loan;
- lever arm, which is calculated as the ratio of loan to equity.
From this concept follows five basic rules of loan funds:
- Profitability of new borrowing is dependent on the future value of the differential.It should follow very closely the fluctuations in this indicator.So, while building the "lever arm" the bank compensates for the risk of the occurrence of an increase in the price of credit.Sufficient capabilities in this area are companies that have a large supply of the differential.
- lender's risk is inversely proportional to the magnitude of the differential.Thus, with less risk of high index, it is at a lower value, respectively, increases.
- When considering the possibility of obtaining credit during the calculations necessary to exclude the amount payable.
- financial stability of the enterprise depends on the proportion of loans, so to obtain new loans must be treated very cautiously.
- optimal level of loans considered to be their share in the 40 percent of all assets of the enterprise.This figure is equivalent to the value of the lever 0.67.
By increasing the share of loans in the balance sheet structure increased financial leverage, which is able to generate a certain risk.And this is a prerequisite for becoming dependent on lenders in the event of late repayment of credit, which leads in turn to a loss of liquidity and financial stability.
for banking institutions is very important to have the potential borrower there was a negative value of the differential.Some experts believe the economic sphere, the effect of financial leverage to achieve its optimum should be one third of the return on assets.
other words, the rate of profitability depends on the successful management of the size of this value.Only with this, the effect of financial leverage shows the probability of compensation of tax exemptions and ensuring their own means.
For details on these concepts you need to understand the principle of operation of financial leverage and the formula by which it is calculated.
leverage effect determines the fluctuation of the value of net income per share calculated in percentages.Thus, the differential is taken into account indicators based taxation, ietwo-thirds of the resulting differences in profitability and interest rates.Taking into account the definition of the lever arm, can derive the following formula:
EGF = 2/3 (ER - SP) * (AP / CC),
where ER - economic profitability.
joint venture - the rate of interest on loans.
AP - the amount of borrowings.
SS - amount of own funds.
Based on the formula, we can conclude that in the prediction of the company in the financial and economic sphere should be considered a shoulder depending on the value differential.
Calculate optimal leverage effect - the task of science fiction.After having today a favorable lever arm is not known what tomorrow will be the economic profitability and the interest rate (differential).Thus, the attraction of additional funds in the form of loans is an incentive to the development of enterprises, and some risk of material losses in the future.
Therefore, the main task of the manager of any company lies in the exclusion of financial risks, taking only calculated using the leverage effect.
