Archimedes once said, "Give me a fulcrum and I can pry up the whole earth." The so-called financial leverage effect is similar, but the fulcrum of financial leverage is debt. If the liabilities are appropriate, the resulting change rate of earnings per share of common stock will be much greater than the change rate of earnings before interest and tax. Just as Archimedes can pry up the whole earth with only one arm. According to this view, only if the profit rate is large enough, the more debts the enterprise has, the less self-owned funds it uses, and the greater the space for financial leverage. However, as we all know, the position of the fulcrum is directly related to whether it was pried up by the earth or by the earth. Similarly, the amount of debt is also related to whether you make a lot of money or lose a lot of money.
Amplification effect of financial leverage
The company is valuable because it can continuously create profits for shareholders and provide return on investment. Therefore, the value of shareholders' investment depends on the possible return on investment provided by unit investment. Profitability is the goal that the company can establish and strive to pursue. In the absence of debt, the return on equity of shareholders (the return of every dollar invested by shareholders) is consistent with the return on assets of the company (the profit generated by every dollar invested by the company). However, if we observe the actual company operation, we find that few companies have the same two indicators. For example, if we look at the annual reports of Microsoft, Wal-Mart, IBM and General Motors in 2007, we can find that their return on assets is 22%, 8%, 9% and 3% respectively, but their return on equity is 44%, 20%, 33% and 18% respectively. Obviously, the returns provided by these companies to shareholders are far higher than their respective return on assets. The reason is that these companies make full use of the amplification effect of financial leverage.
In fact, Microsoft's return on assets is the highest (22%), Microsoft's debt-amplified return on equity is almost 2 times (45%), while GE's return on assets is the lowest (3%), and GE's debt-amplified return on equity is almost 6 times (65,438+08%). If we further observe the asset-liability ratio of these four companies, it is not difficult to see that the asset-liability ratio of finance Microsoft is 50%, while that of GE is over 80%. So the 70% asset-liability ratio you gave is the same.
Borrowing seems to have many advantages but no disadvantages. It can not only effectively enlarge the return on net assets, but also has the advantages of tax shield and alleviating the agent problem. So, is it better for enterprises to borrow more? Actually, it is not.
First of all, the higher the debt ratio of enterprises, the higher the interest rate required by banks, which requires enterprises to have a higher rate of return on assets to pay bank interest rates, which invisibly increases the risk of business operations.
Secondly, too much bank debt will increase the pressure of fund scheduling in operation, thus reducing financial flexibility. When this pressure reaches a certain level, it is easy to cause the debt crisis and credit crisis of the company, leading to the break of the capital chain, and the impact of this crisis on the normal operation of the company may be immeasurable, and sometimes even overwhelming.
Therefore, enterprises should not only consider the industry characteristics, development cycle, asset composition and profitability of enterprises, but also consider the possible costs of corporate debt crisis, so as to maintain the optimal capital structure. What is the best? It is difficult to get an accurate value in theory, which requires the experience and intuitive judgment of entrepreneurs.