Financial leverage or financial collapse?

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Throughout the times, technologies, cultures, lifestyles and beliefs have changed, but only one thing has remained unchanged - money. For centuries, they have been daily present in people's lives, performing their functions. However, during the time of the Knights Templar, the development of the financial sector acquired a special meaning, systems and laws were developed that are still in use. We will talk about one of these systems today.

Financial leverage is a joint impact on the amount of profit with the help of own and borrowed funds. In order to better clarify this concept, let's consider the following example: the company's management decided to implement one of the projects that is guaranteed to bring profit, but there are not enough own sources of financing, because. profits are limited and often located in various assets. Borrowed funds help to get the necessary amount in the right amount on time - this is the financial leverage.

It should be understood that such measures are an objective necessity and are designed to increase the return on your capital. It is important to realize that financial leverage (leverage) is not an ordinary situation for taking a loan forundefined goals. At this step, all possible options are carefully calculated, it is checked whether the company is ready for the requirements for this stage. For example, in margin trading, financial leverage is available only if the share of capital is at least 50% of equity.

In the modern world, this tool is most often used by traders in assets, resources, currencies, or just speculators. Often, in order to get a good profit on transactions in this area, they do not have enough equity capital, and therefore they resort to the services of investors and creditors. In addition to objective reasons, calculations are carried out related to possible losses or gains upon completion of the entire project. It is this fact that shows how much financial leverage is really needed. The calculation formula is very simple and it looks like this:

EFF=(1 - T) x (RA - RD) x (D\E), where:

T - income tax (decimal expression);

RA - return on assets of the company in% (pages 190 and 300 of Form No. 2);

RD - interest on the loan;

D - amount borrowed;

E - the total amount of your capital (line 490 of Form No. 1).

There can only be two results. If the answer is minus, then the financial leverage will only aggravate the situation in your company, but if it is a plus sign, then you have a good chance to increase your profit.

I would also like to say a few words about the very essence and significance of such an instrument for you:

1) the morethe money you borrowed, the greater the risk of failure;

2) financial leverage makes your firm dependent on creditors or investors;

3) such agreements oblige you to make monthly and other payments, which, with a decrease in profits and net of taxes, may force you to liquidate part of the assets;

4) even a small increase in profits through leverage can significantly increase your “white” revenue.

If you do not use financial leverage and all your activities are carried out at the expense of equity and profit, then, by all the rules of financial science, your company is recognized as financially independent.