What Is the Connection Between Leverage and Capital Structure?

The concept of financial leverage: Financial leverage is also called financing leverage or financing leverage. It refers to the phenomenon that the change in the earnings per share of ordinary shares is greater than the change in earnings before interest and taxes due to the existence of fixed debt interest and preferred stock dividends.

Financial leverage

Financial leverage is a widely used concept. In physics, with a lever and a fulcrum, you can lift a heavy object with a small amount of force. What is financial leverage? From the west

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Risk is a concept related to loss, and it is a kind of uncertainty or possible loss.

Whether the financial leverage has a positive or negative impact on the company's operations depends on the company's

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(Benefit on Financial Leverage)

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Proper use of financial leverage will give companies

The main indicator of financial leverage measurement is

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The Principle of Financial Leverage and Its Application in University Financial Analysis

I. Financial leverage and financial leverage

In corporate financial management, financial leverage arises because of the total capital of an enterprise, the cost of funding for debt financing is relatively fixed. Due to the fixed interest expenditure caused by the financing of corporate debt, the shareholder income of a company is volatile, and its change will be larger than the change in earnings before interest and taxes.The impact of this debt on investor income is called financial leverage. The degree of influence is usually expressed by the financial leverage factor, and its calculation formula is as follows:

Financial leverage factor = total EBIT ÷ (total EBIT-interest expense) = total EBIT ÷ pretax income

Due to the special nature of colleges and universities, income tax can be ignored. Based on the same principle, it reflects the degree of influence of college debt financing on the variability of net asset accumulation. The formula for calculating the financial leverage factor can be expressed as:

Financial leverage factor = (total income-total expenses + interest expenses) ÷ (total income-total expenses) = net interest-bearing balance ÷ net balance

According to the theory of financial leverage, the benefit of financial leverage refers to the additional benefits brought to the accumulation of net assets by using debt financing. When analyzing the financial leverage of universities, the benefits of net asset accumulation come from net balances. It includes the following two situations:

1. Leveraged benefits under constant capital structure and changes in net interest-bearing balances. Under the condition of a certain capital structure, the interest paid on debts paid by universities is fixed. When the net interest-bearing balance increases, the fixed interest expenditures borne by the unit net interest-bearing balance will decrease, and accordingly, the net balance will be more stable. If the increase is large, then financial leverage benefits can be obtained. Conversely, when the net interest-bearing balance decreases, the fixed interest expenditures borne by the unit's net interest-bearing balance will increase, and the net balance will decrease accordingly.

2. Leverage benefits under the same interest-bearing net balance and capital structure changes. In a certain case of interest-bearing net balance, if the interest-bearing asset balance ratio is greater than the debt interest rate, a portion of the remaining vesting net assets is used. Under this premise, the greater the proportion of liabilities in the total funding source, the more The higher the financial leverage, the greater the benefit; and when the balance of interest-bearing assets is less than the interest rate on liabilities, the accumulation of some net assets must be used to pay the interest on the liabilities, and financial leverage will have a negative effect. The greater the proportion of sources, the lower the net asset balance ratio.

Relationship between financial risk and financial leverage

Financial risk refers to the variability of shareholders' income and the uncertainty of debt repayment ability caused by debt financing. It is also called financing risk or borrowing risk. As long as an enterprise has liabilities, there are financial risks.

The financial risks of colleges and universities are also because of the cost of borrowing funds, the uncertainty of the financial situation caused by changes in internal and external environmental factors, and the inability of colleges and universities to fully assume their social functions, provide public goods and even endanger their survival. Sex. This kind of risk will lead to insufficient liquidity in the operation of colleges, no or lack of daily operating expenses, arrears of teachers' salaries, failure to repay the principal and interest of bank loans, and putting colleges into a financial crisis.

The impact of corporate financial leverage on financial risk is comprehensive. With the same capital structure, the greater the financial leverage factor, the greater the elasticity of the rate of return on capital before interest and tax. If the rate of interest before tax increases, the rate of return on capital will increase at a faster rate. If the EBIT margin decreases, then the capital profit margin will decrease at a faster rate, and the greater the risk.

Conversely, the smaller the financial risk. If the profit before interest and taxes falls to a certain level (with the interest rate on assets before interest and taxes equal to the turning point of the interest rate on liabilities), the financial leverage will change from positive to negative. Using financial leverage at this time will reduce the The level of income that should have been obtained in the case of financial leverage, and the greater the financial leverage factor, the greater the loss, and the greater the financial risk.

If financial leverage is not used, the above losses will not occur, and there will be no financial risks, but when the operating conditions are good, leverage benefits will not be obtained. Companies must make a reasonable trade-off between this benefit and risk.

The same is true for colleges and universities. The development of debts also uses the benefits of financial leverage. Financial leverage can also be used to analyze financial risks. Financial leverage factor indicates the magnitude of financial leverage, and reflects the risks brought by the school's borrowing funds. When all the funds of colleges and universities are their own funds, the financial leverage factor is 1, that is, the change in the net interest-bearing balance is equal to the change in the net balance, and the financial risk is equal to zero. Generally speaking, the greater the financial leverage factor, the greater the financial leverage, and the greater the financial risk; on the contrary, the smaller the financial leverage factor, the smaller the financial leverage, and the smaller the financial risk.

Therefore, colleges and universities can use the principle of financial leverage and adopt a moderate debt method to obtain the benefits of financial leverage. At the same time, attention should be paid to changes in the conditions of use, to reasonably predict and control financial risks.

Because there are many factors that affect financial risk, many of them are uncertain. Therefore, financial risk management in universities is also a complicated task.

Third, the problems that colleges and universities should pay attention to when applying the principle of financial leverage

When universities apply the principle of corporate financial leverage to analyze financial risks, they should pay attention to the following issues:

1. The financial risks of colleges and universities are different. The financial risks of colleges and universities have their special characteristics: the use of funds must be within means. On the premise that there is a higher amount of bank credit funds to repay principal and interest, the financial budget of colleges and universities must collect more than the expenditure, and the difference is the part that can be used to return the principal and interest of financial institutions and the mobile funds for school development. Colleges and universities are not-for-profit organizations. Compared with enterprises, colleges and universities cannot increase the remaining funds in terms of cost control and sales expansion, that is, there are non-compensatory costs and expenses, and there are fewer ways to increase revenue and reduce expenditures. In financial leverage, the net interest-bearing balance is a crucial condition. Therefore, in the financial budget, it is required to achieve more revenue than expenditure and a balance of revenue and expenditure.

2. Changes in interest rate levels. This is one of the factors affecting financial risk. The above analysis is based on the premise of fixed interest, that is, the interest rate of the liability is unchanged. In the case where the net interest-bearing balance and the debt ratio are constant, the higher the interest rate of the liability, the greater the financial leverage; conversely, the smaller the financial leverage, that is, the effect of the interest rate of the liability on the financial leverage changes in the same direction of. Its impact on the net asset balance rate is changing in the opposite direction, that is, the lower the interest rate of the liability, the net asset balance rate will increase accordingly. The rise of interest rate will increase the cost of debt funds of colleges and universities, offset the expected returns, and thus increase the risk of raising funds. Colleges and universities should choose funds with low interest rates as much as possible to reduce capital costs.

3. The effect of increasing the proportion of debt on the increase of the net asset balance ratio is based on the premise that the interest-bearing asset balance ratio is greater than the debt interest ratio. If the interest-bearing asset balance ratio is greater than the liability interest rate, there is a positive effect of financial leverage.You can increase the ability to accumulate net assets by borrowing funds to obtain financial leverage benefits as much as possible.When the interest-bearing asset balance ratio is less than the debt interest rate, Should reduce the level of debt or the proportion of debt as much as possible, so as to reduce financial leverage losses.

In short, because borrowed funds need to repay principal and interest, once the debts are unable to pay due, colleges and universities will fall into financial difficulties. Therefore, when using debt funds to develop, colleges and universities must not only focus on obtaining financial leverage benefits, but also must guard against financial leverage losses. Prevent financial risks.

In summary, financial leverage can bring additional benefits to the enterprise and may also cause additional losses. This is an important factor that constitutes financial risk. Financial leverage does not increase the wealth of the whole society, it is the distribution of established wealth between investors and creditors; financial risk does not increase the risk of the whole society, it is the transfer of operating risks to investors. Financial leverage benefits and financial risks are an important factor in corporate capital structure decisions. Capital structure decisions require a reasonable trade-off between leveraged interests and the risks associated with them. Any practice that only cares about obtaining financial leverage benefits and ignores financial risks and uses financial leverage inappropriately is a major mistake in corporate financial decisions and will ultimately harm the interests of investors. ^[2]