The term financial leverage refers to a group of important indicators of a company's financial soundness. Next to this concept are the coefficients of autonomy and financial dependence, which also reflect the proportion between the organization's own and borrowed funds.
Financial leverage (leverage, leverage, leverage) is the ratio of borrowed funds to personal funds (in other words, the correspondence between borrowed and personal capital). In addition, the concept of financial leverage includes the effect of the use of borrowed funds in order to increase the size of transactions and benefits without having the required amount of funds. At the same time, the ratio of the amount of credit funds to personal capital characterizes the level of risk and economic stability.
Economic leverage can be used only if the seller attracts borrowed funds. The payment for the loan capital is usually less than the added value it guarantees. It is added to the profit on personal capital, which allows you to increase its profitability.
In the commodity, stock and money markets, the concept of financial leverage is modified into margin requests - the percentage of funds that a seller must have on his balance sheet to complete a transaction to the total value of the transaction being concluded. Usually, on the commodity market, 50% of the total transaction amount is required, that is, to resolve the $ 200 contract, the seller must own at least $ 100. In the market for derivative financial instruments or foreign exchange, for example, a futures contract, it is necessary to make a guarantee in the amount of 2 to 15% of the contract price, that is, to conclude an agreement for $ 200, it is enough to have from 4 to 30 $ available.
Financial Leverage Ratio = Liabilities / Equity
Both the numerator and the denominator are taken from the liability of the organization's balance sheet. Obligations in the calculations are taken both long-term and short-term.
An equilibrium ratio of credit and equity capital (when the financial leverage ratio is equal to 1) is considered optimal, especially for Russian companies. A value of up to 2 may also be acceptable (for large public companies, this ratio may be even higher).
The introduction of increased credit leverage increases not only the likelihood of receiving benefits, but also the degree of risk of such an operation.
Global trading with the introduction of a monetary leverage effect is considered the promise of monetary decline. One of the clearest examples of this is the collapse of the British Bering Bank, which was one of the oldest and largest banks in the world.
Most often, players use financial leverage in order to increase their income. But, in accordance with the rule of leverage, the possible loss also increases by a similar number of times.
