# Interaction of financial and operational leverage

Financial management

The capital structure of the company is related to the so-called financial liverydzhem. Generally in the practice of financial management liverydzh seen as a lever, allowing little effort due to significantly alter the results of financial and economic activities.

The operating lever (liverydzh), as noted in Section 5, is a potential enterprise opportunities to influence the rate of change in operating profit by changing the volume and structure of operating costs (fixed and variable).

That is, the strength of operating leverage shows the percentage change in operating profit when changing sales revenue by 1%.

Financial leverage (liverydzh) is a potential enterprise opportunities to influence the rate of change in net profit by changing the amount and structure of equity and debt.

Thus, the strength of financial leverage shows how many times the rate of change in net profit growth rate higher than its operating profit. Such excess is provided by the so-called effect of financial leverage.

The effect of financial leverage shows the percentage increases return on equity by attracting businesses into the economy of debt, despite its paid character. The increase of financial profitability (ie return on equity) can take place only when the economic return on the use of all invested capital greater than the average financial costs associated with the borrowing of funds.

The effect of financial leverage consists of two components:

1. Differential (1 - Copy) (ERA-SP) - the difference between the return on invested capital and average interest rate on borrowings after tax;

2. Shoulder PC / VC - the ratio of debt and equity.

Leverage is the financial leverage multiplier differential changes, that enhances its performance both in positive and negative directions. Thus, if the differential is positive advantageous to increase the proportion of debt and thus increase return on equity. Conversely, if the differential is negative, by increasing the shoulder of financial leverage is 'eating' equity, and the consequences for the enterprise can be devastating.

Consider the method for determining the effect of financial leverage and power of action in a particular case.

Thus, the return on equity greatly depends on skilful maneuvering largest effect of financial leverage. Up to a certain point to increase the effect of financial leverage can be extensively by increasing his shoulder. But it is necessary to consider the following rules of financial management:

1. You can not unduly increase the share of borrowed funds in the capital structure, as this significantly increases the risk of losing financial stability, and any delays in the production process or adverse changes in market conditions (in credit markets, finished goods, raw materials, etc.) can lead to significant negative value effect of financial leverage.

2. Adjust the value of the lever arm can only be based on the value differential. More opportunities for increasing loan capital are those enterprises in which a substantial margin differential. But it must be remembered that changing the shoulder of financial leverage in turn affects the size differential. The more shoulders, the more expensive will cost for the company borrowed financial resources due to the inclusion of the cost of the risk premium.

3. An enterprise should always keep a reserve borrowing capacity, if necessary to be able to cover the need for financial resources through new credit and it does not change the sign of the differential with a "+" to "-". Experienced financial managers are trying to maneuver within the optimal range deleveraging in capital (from thirty to 50%). As the experience of highly developed countries, it is best to maintain the proportion of debt at 40% (corresponding to the arm lever 0.67), since in this case the stock market the best estimates shares.

Indicator force of the financial leverage of the financial risks associated with capital structure. The higher this value, the greater the risk of bad loans with interest for bankers and risk of non-payment of dividends to shareholders. The situation is further complicated when both increased commercial risk which is the risk of a shortfall in operating profit from core operations of the company.

Bold as a part of total risk capital owners of commercial and financial risks is essential for substantiation of optimal capital structure.

Thus, the operational and financial leverage shows how changes per cent net profit enterprise that uses borrowed capital, changing sales revenue by 1%.