Financial leverage is an important analytical tool for enterprise financial management. Company management can use several levers in financial management to grasp the "degree" of investment and financing decision-making and make corresponding evaluation. Most scholars describe the application principle of leverage in financial management vaguely. This paper will explain how to understand the leverage principle from a clearer and more intuitive perspective, and how to use the leverage principle to evaluate the company's operation and financial situation.
First, the essence of leverage principle in financial management
The essence of leverage principle in financial management can be summarized as the utilization degree of fixed costs or expenses in each accounting period. The fixed costs or expenses mentioned here are divided into two categories: (1) fixed costs or expenses arising from business activities (hereinafter referred to as fixed costs), such as depreciation of fixed assets, salaries of employees, office expenses, etc. ; (2) The fixed costs or expenses incurred by enterprises in fund-raising activities (hereinafter referred to as fixed financial expenses) are mainly reflected in the interest of debt capital or dividends payable for issuing stocks. In the following analysis, the author assumes that the interest on debt capital is the only fixed financial expense in financing activities.
Second, an important indicator to describe the company's operating conditions-operating leverage.
Operating leverage refers to the extent to which an enterprise uses the fixed costs generated by its business activities. When the income of an enterprise's main business changes, this change will eventually lead to the change of its operating results (earnings before interest and tax and EBIT) through the fulcrum (fixed cost). The author intends to analyze the degree and reasons of this change from the perspective of the benefits and risks of operating leverage.
(A) the description and evaluation of operating leverage's interests
Operating leverage's interest refers to the contribution and amplification of the increase of main business income to the income before interest and tax under the condition that the fixed cost or the position of leverage fulcrum remains unchanged. The author intends to take Company A as an example to illustrate, and the relevant business activity information is shown in Table 1:
Table 1 unit: 10,000 yuan
Annual main business income main business income
Variable cost of growth rate
(accounting for 60% of the main business income) fixed cost EBIT EBIT
growth rate
2004 2400 1440 800 160
2005 2600 8% 1560 800 240 50%
2006 3000 15% 1800 800 400 67%
As can be seen from table 1, when the main business income in 2005 increased by 8% compared with that in 2004, the corresponding EBIT increased by 50%, and the EBIT increased greatly. When the main business income in 2006 increased by 15% compared with that in 2005, the corresponding EBIT in earnings before interest and tax increased by 67%, and the growth rate of EBIT was also very large. In other words, a small increase in the main business income will lead to a substantial increase in EBIT, because of the existence of leverage fulcrum or fixed costs, thus generating leverage benefits. The above analysis can be described by figure 1:
(2) Description and assessment of risks in operating leverage.
Operating leverage risk refers to the operational risk brought by the rapid decline of EBIT when the income of the main business declines. Assume that the related business activity information of Company A is shown in Table 2:
Table 2 Unit: ten thousand yuan
Annual main business income main business income
Variable cost of growth rate
(accounting for 60% of the main business income) fixed cost EBIT EBIT
growth rate
2004 3000 1800 800 400
2005 2600 - 13% 1560 800 240 -40%
2006 2400 -8% 1440 800 160 -33%
As can be seen from Table 2, when the main business income in 2005 decreased by 13% compared with that in 2004, the corresponding EBIT decreased by 40% and EBIT decreased significantly; In 2006, the main business income decreased by 8% compared with that in 2005, and the corresponding EBIT in earnings before interest and tax decreased by 33%, and the decline of EBIT was also great. In other words, a small decline in the main business income will lead to a significant decline in EBIT, because of the existence of leverage fulcrum or fixed costs, thus creating leverage risk. The above analysis can be used in fig. 2.
3) Measurement of operating leverage effect.
From Figure 1 and Figure 2, it can be seen intuitively that a small change in main business income will lead to a big change in EBIT, that is, through the transfer of leverage or fixed costs, either operating leverage gains or operating leverage risks will be generated. How to accurately reflect the operating leverage effect from a quantitative point of view can still be analyzed with Figure 1 and Figure 2. According to the analysis, the operating leverage effect can be described by the sensitivity of earnings before interest and tax to the change of main business income, and thus the basic formula for measuring the operating leverage coefficient of operating leverage effect is derived from an intuitive perspective:
Operating leverage coefficient = earnings before interest and tax EBIT change rate/main business income change rate.
Three, an important indicator to describe the company's financial situation-financial leverage
Financial leverage refers to the degree of utilization of fixed financial expenses generated by financing activities (debt financing). When an enterprise's earnings before interest and tax (EBIT) changes, this change will eventually lead to the change of enterprise's net profit through the fulcrum, that is, fixed financial expenses. The author will analyze the degree and reasons of this change from the perspective of financial leverage income and risk.
(A) the description and evaluation of financial leverage benefits
Financial leverage refers to the contribution and amplification of earnings before interest and tax to net profit under the condition of fixed financial expenses or unchanged lever fulcrum position. Suppose that the related business activity information of Company A is shown in Table 3:
Table 3 Unit: ten thousand yuan
Annual income before interest and tax Annual income growth rate before interest and tax Debt interest income tax (33%) Net profit growth rate
2004 160 150 3.3 6.7
2005 240 50% 150 29.7 60.3 800%
2006 400 67% 150 82.5 167.5 178%
As can be seen from Table 3, earnings before interest and tax in 2005 increased by 50% compared with 2004, and the corresponding net profit increased by 800%, with a very large increase in net profit; Compared with 2005, the profit before interest and tax in 2006 increased by 67%, corresponding to the net profit growth of 178%, and the net profit also increased significantly. In other words, a small change in earnings before interest and tax will lead to a very big change in net profit, because of the existence of leverage fulcrum or fixed financial expenses, thus generating financial leverage benefits. The above analysis can be described with Figure 3.
(B) the description and evaluation of financial leverage risk
Financial leverage risk refers to the huge risk brought by the sharp decline of net profit due to the decrease of income before interest and tax when the financial expenses or the position of leverage fulcrum remain unchanged. Suppose that the related business activity information of Company A is shown in Table 4:
Table 4 Unit: ten thousand yuan
Annual income before interest and tax Annual income growth rate before interest and tax Debt interest income tax (33%) Net profit growth rate
2004 400 150 82.5 167.5
2005 240 -40% 150 29.7 60.3 -64%
2006 160 -33% 150 3.3 6.7 -89%
As can be seen from Table 4, earnings before interest and tax in 2005 decreased by 40% compared with that in 2004, and the corresponding net profit decreased by 64%, and the net profit decreased greatly. Compared with 2005, the profit before interest and tax in 2006 decreased by 33%, the corresponding net profit decreased by 89%, and the net profit decreased greatly. That is to say, the decrease of income before interest and tax will lead to great changes in net profit, because of the existence of leverage fulcrum or fixed financial expenses, thus generating financial leverage risk. The above analysis can be described with Figure 4:
(C) the measurement of financial leverage effect
It can be intuitively seen from Figure 3 and Figure 4 that a small change in earnings before interest and tax will lead to a big change in net profit, that is, financial leverage gains and financial leverage risks will be generated through the transfer of leverage fulcrum or fixed financial expenses. How to accurately reflect the financial leverage effect from a quantitative point of view can still be analyzed from Figure 3 and Figure 4. The analysis shows that the financial leverage effect can be described by the sensitivity of net profit to the income before interest and tax changes, from which the basic formula of financial leverage degree is derived to measure the financial leverage effect from an intuitive point of view:
Degree of financial leverage = rate of change of net profit/rate of change of earnings before interest and tax.
Four. Comprehensive leverage-an important indicator to describe the overall operating conditions of a company
Comprehensive leverage should be understood as the comprehensive utilization degree of the above-mentioned fixed costs and fixed financial expenses, that is, the main business income of an enterprise is conducted through operating leverage fulcrum O 1 and financial leverage fulcrum O2, so that the operating results (net profit) of an enterprise have a great change relative to the change of main business income, and the degree of change depends on the * * * interaction of the two leverage fulcrums. Taking the above information as an example, the author uses Figure 5 to describe it:
As can be seen intuitively from Figure 5, when the income of the main business increased by 8%, the net profit increased by 800% through the interaction between the fulcrum O 1 and the fulcrum O2, which was very large, because the lever was greatly enlarged by two points. As can be seen from the analysis of Figure 5, the comprehensive leverage effect can be measured by the sensitivity of net profit to the change of main business income, or by the superposition of operating leverage and financial leverage, and thus two basic formulas for measuring the comprehensive leverage coefficient are obtained from an intuitive perspective:
Comprehensive leverage coefficient = change rate of net profit/change rate of main business income
= operating leverage coefficient χ degree of financial leverage
To sum up, how to find a fulcrum position O on the above-mentioned operating leverage (or financial leverage) and convert it into determining the appropriate fixed asset investment scale (or debt financing scale) so that the interests and risks of the enterprise's operating leverage or financial leverage can reach an acceptable level; At the same time, in order to reduce the overall business risk and financial risk of the enterprise, the management of the enterprise can make use of the analysis method in this paper and consider the relative position of the financial leverage fulcrum and the operating leverage fulcrum with intuitive thinking, so as to make a satisfactory decision.