Moderately Debt Management And Creating Financial Leverage Effect

Archimedes once said, "give me a fulcrum, and I can pry up the whole earth."

The so-called financial leverage effect is similar to that, but the fulcrum of financial leverage is debt.

If the liabilities are appropriate, the rate of change in earnings per share generated by the common stock will be much greater than that before interest tax.

Just as Archimedes can only pry up the whole earth with the strength of one arm.

According to this view, only if the profit margin is large enough, the more liabilities the company has, the less funds will be used, so the greater the financial leverage effect will be.

However, as everyone knows, the placement of fulcrum is directly related to whether it is prized or prized by the earth.

Similarly, the amount of debt is also related to making money or losing money.

The reason why a company has value is that it can continuously generate profits for shareholders and provide return on investment.

Therefore, the size of shareholders' investment value depends on the size of the investment return that the unit investment may provide.

Profit is the goal that the company is able to establish and strive to pursue. In the absence of debt, the rate of return on the equity of the shareholders (the return of every dollar invested by the shareholders) is in accordance with the company's return on assets (the profit produced by the company per piece of money).

But if we look at the actual operation of the company, we find that almost a few companies are exactly the same two.

For example, we observed the annual reports of Microsoft, WAL-MART, IBM and general motors in 2007, and found that their assets return rates were 22%, 8%, 9% and 3% respectively, but their return on equity were 44%, 20%, 33% and 18% respectively.

Obviously, these companies offer returns to shareholders far more than their respective asset returns.

The reason is that these companies make full use of the magnifying effect of financial leverage.

The company will generate various liabilities in the course of production and operation.

The most common forms of liabilities are suppliers' payment, wages payable, taxes payable and other arrears in other activities.

In general, these arrears are in the normal production and operation process of the company, occupying resources of other companies or individuals without compensation, which virtually magnifies the capital invested by shareholders in the company.

The profits generated by this part of the capital are attributable to the remuneration of the shareholders of the company. Because the equity reward ratio = profit / interest, these liabilities obviously increase profits and have no impact on the rights and interests, thereby increasing the rate of return of shareholders.

In this sense, the more money the company has to pay, the higher the rate of return will be.

Of course, when a company takes up funds from other companies or individuals, your downstream customers will also take up your money without compensation, that is, you owe others money, others also owe you money.

Only when you owe other people more money than anyone else owes you will the company's interest rate be increased.

DELL is a good example of the successful use of this strategy.

Over the past 10 years, DELL has increased its debt to other people by increasing the accounts payable period (from 39 days in 1996 to 74 days in 2005), shortening account receivables (shortened from 44 days in 1996 to 30 days in 2005), reducing other people's liabilities to them, and effectively improving the liabilities that enterprises do not pay interest in the course of operation, thus achieving a high return on equity.

Although the interest free debt has no cost of capital, it may be a gain for enterprises occupying this debt, but this does not mean that there is no price for interest free liabilities.

Under normal circumstances, the interest free liabilities occupy the resources of the upstream and downstream enterprises, which damage the interests of business partners. Although the enterprises that can occupy these resources have larger voice in the enterprises and ecological chain because of their large size, they will inevitably affect the credit relationship between the company and the upstream and downstream enterprises as a strategy.

In the short term, this strategy of "bullying the small" may not be the only way for a relatively disadvantaged enterprise, but in the long run, the accumulation of this credit risk usually affects the development of the enterprise itself, and even brings about a disaster.

Therefore, what kind of credit management strategy should be established is obviously not only considering the bargaining power of the enterprise itself, but more importantly, it should consider how to maintain the equilibrium relationship in the entire ecological chain.

For the vast majority of enterprises, their claims and debts are usually offset.

Borrowing from banks is the most common way to borrow money in normal business process. However, how much money can be borrowed and how much interest can be borrowed will depend on the company's ability.

Just imagine, how can you lend money to a person who has no family and can't afford to eat? He can't be dragged into the bottomless pit.

Similarly, if the proportion of borrowings in the company's net assets is relatively small, the risk of borrowing from banks is relatively small. Enterprises can usually obtain such loans at relatively low cost.

If a company borrows far more than the company's net assets, the risk of borrowing will increase. Accordingly, banks will also ask for higher interest rates to compensate for the risk of borrowing.

But in any case, the company usually borrows money from the bank.

.

However, it is worth exploring that the interest of bank loans can usually be included in the pre tax cost of corporate finance, so interest will have the function of "tax shield".

For example, if the enterprise's income tax rate is 50%, and the bank loan interest rate is 10%, then, from the after tax profit, the bank loan interest rate of the enterprise is only 5%.

Because 5% of the cost of borrowing was offset by income tax.

In this sense, the government encourages enterprises to borrow money.

Whether enterprises are suitable for borrowing is not only to see the interests of debt raising in tax shields, but also to make reasonable financial planning according to the needs of enterprise development, and to determine appropriate debt ratio according to the actual demand of funds.

Bank borrowing will reduce the contribution of debt management to raise net assets return rate due to interest. However, if the pre tax return of capital invested by enterprises is higher than that of bank borrowings, borrowing will surely have a positive effect on net asset return after tax.

Conversely, if the return of investment capital is lower than the current financial market interest rate, the impact of debt on return on net assets is negative.

For example, A and B have the same investment capital of 100 million yuan, but the financing structure is different.

One of them is fully equity financing, half of which is equity financing and the other half gets debt financing at 10% interest rate.

Under different profit levels, the impact of liabilities on return on net assets is quite different.

enterprise

In addition to the advantages of tax, it usually reduces the cost of agency.

Because in the environment of corporate debt management, management will always face the pressure of repayment, which may virtually reduce the abuse of residual cash by management, thereby inhibiting blind investment behavior.

From the above analysis, we can see that borrowing seems to be profitable.

It can effectively enlarge the rate of return on equity, and at the same time has the advantages of tax shield and alleviating agency problems. So the more debt ratio is, the better.

First of all, the higher the debt ratio, the higher the interest rate required by banks. This requires higher return on assets to pay bank interest rates, and virtually increases the risk of enterprise operation.

Secondly, excessive bank liabilities will increase the pressure of fund management in operation and reduce financial flexibility. When this pressure reaches a certain level, it will easily lead to the debt crisis and credit crisis of the company, causing the capital chain to break up, and this crisis is against the company.

The influence may not be properly measured and sometimes even destroyed.

Therefore, the moderate borrowing of enterprises should consider the industry characteristics, development cycle, asset composition and profit level of enterprises. At the same time, it is necessary to consider all kinds of costs that may arise from the company debt crisis, so as to maintain an optimal capital structure.

What is the best? In theory, it is difficult to produce an accurate value. It requires the entrepreneur's experience and intuition to judge.

Therefore, in this sense, we call debt management an art.

For more information, please pay attention to the world clothing shoes and hats and Internet cafes.