Over the years, technology, culture, lifestyle and beliefs have changed, but only one thing has remained unchanged - money. For centuries, they are daily present in people's lives, performing their functions. However, during the time of the Templar Order, the development of the financial sector acquired a special meaning; the systems and laws that were still in use were developed. We’ll talk about one of these systems today.
Financial leverage is a joint effect on the amount of profit with the help of own and borrowed funds. In order to better clarify this concept, let's look at the following example: the management of the company decided to implement one of the projects that is guaranteed to bring profit, but its own
sources of financing are not enough, because profit is limited and often located in various assets. Borrowed funds help to get the required amount in the right amount on time - this is financial leverage.
It is worthwhile to understand that such measures are an objective necessity and are designed to increase the profitability of your capital. It is important to realize that financial leverage (leverage) is not an ordinary situation for taking a loan for vague purposes. With 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 of assets, resources, currency or just speculators. Often, in order to get good profit on transactions in this area, they do not have enough equity, 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 acquisitions 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:
EGF = (1 - T) x (RA - RD) x (D \ E), where:
T - income tax (decimal);
RA - the return on assets of the company in% (p. 190 and 300 of form No. 2);
RD - interest on the loan;
D - loan amount;
E - the total amount of your capital (page 490 of form No. 1).
There can only be two results. If the answer is with a minus, then financial leverage will only aggravate the situation in your company, but with a plus sign, then you have a good chance to increase your profit.
I would also like to say a few words about the essence and significance of such an instrument for you:
1) the more money you borrowed, the greater the risk of failure;
2) financial leverage makes your company dependent on lenders or investors;
3) such agreements oblige you to make monthly and other payments, which, with a decrease in profit and less taxes, may force you to liquidate part of the assets;
4) even a small increase in profits by attracting borrowed capital 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.