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 a goal that a company can establish and strive for. When a company is not in debt, the return on equity of shareholders (the return paid by each shareholder invested by a shareholder) is consistent with the return on assets of the company (the profits generated by each company invested in one yuan).

However, if we observe the actual operation of the company, we find that very few companies have the same two indicators.

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.

From the right picture, we can see that Microsoft's assets return rate is the highest (22%), Microsoft's liability to magnify the returns to equity is almost double (45%), while GE's assets return rate is the lowest (3%), and GE's liabilities magnify the return on equity to almost 6 times (18%). If we further observe the 4 companies' asset liability ratio, it is easy to see that financial leverage has magnified the return of the company's equity.

As you can see from the figure below, Microsoft's

At 50%, GE has an asset ratio of more than 80%.

Company in production

Various liabilities will arise.

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 for free,

The higher it 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.