The effect of financial leverage is the indicator of optimal borrowing

The effect of the financial lever has such components:

- differential, which is determined by the difference between the indicator of profitability of assets and the average calculated interest on loans;

- lever arm, which is calculated as the ratio of borrowed funds to own funds.

From this concept follows five basic rules for a loan of cash:

1. The profitability of the new borrowing depends on the value of the differential obtained in the future. At the same time, it is necessary to closely monitor the fluctuations of this indicator. So, with the increase of the "leverage of the lever", the bank compensates for the emergence of the risk by raising the price of the loan. Sufficient opportunities in this direction have businesses that have a large margin of differential.
2. The risk of the lender is inversely proportional to the value of the differential. So, with a larger indicator, there is less risk, with a smaller value, it, accordingly, increases.
3. When considering the issue of the possibility of obtaining a loan during settlements, it is necessary to exclude the amount of accounts payable.
4. The financial strength of an enterprise depends on the proportion of loans, so it is necessary to be very cautious in obtaining new loans.
5. The optimal level of loans is considered to be their share in 40 percent of all assets of the enterprise. This indicator equals the value of the lever 0,67.

With an increase in the share of loans in the balance sheet structure, a financial leverage grows that can generate a certain risk. And this is already a prerequisite for getting into dependence on lenders in the event of untimely repayment of loan funds, which, in turn, leads to a loss of liquidity in financial stability.

For banking institutions it is very important that the potential borrower does not have a negative differential value. Some experts of the economic sphere believe that the effect of the financial lever in order to achieve its optimality should equal one third of the return on assets.

In other words, the profitability index depends on the successful regulation of the size of this quantity. Only with this meaning, the effect of the financial leverage shows the likelihood of compensation of tax exemptions and provision with own funds.

For a detailed familiarization with these concepts, it is necessary to understand the principle of the financial leverage and the formula by which it is calculated.

The effect of the financial lever determines the fluctuation of the net profit per share, calculated as a percentage. So, in the calculation of the differential, the indicators are taken into account with taxation, i.е. Two-thirds of the profit margin difference received and the interest rate. Taking into account the definition of lever arm, we can derive the following formula:

EGF = 2/3 (ER-SP) * (LC / CC),

Where ER - economic profitability.

The joint venture is the interest rate on loans.

ЗС - the amount of borrowed funds.

SS - the amount of own funds.

Proceeding from the formula, we will draw a conclusion that when forecasting the activity of an enterprise in the financial and economic sphere, it is necessary to take into account the leverage, depending on the value of the differential.

Calculate the optimal effect of financial leverage - a task from the field of fantasy. Because having a favorable leverage today, it is not known what tomorrow will be the economic profitability and the interest rate (differential). Thus, attracting additional funds in the form of loans is also an incentive for the development of the enterprise, and a certain risk of material losses in the future.

Therefore, the main task of the manager of any company lies in the elimination of all financial risks, taking only those calculated using the effect of the financial lever.