Leverage

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The gearing ratio ( english debt to equity ratio , gearing or leverage ratio ) of a debtor ( companies , communities or States ) is an economic indicator that the relationship between the balance sheet debt and equity indicates. It provides information about the financing structure of a debtor. As the level of indebtedness increases, the credit risk for creditors increases .

In practice, the term “leverage” is sometimes used as a synonym for “debt ratio”. In business literature, however, the “ debt ratio ” is usually understood to be a separate key figure (namely, debt in relation to total capital).

General

Creditors have an interest in being able to measure their credit risk at any time during the credit period. This requires the transparency of the financial circumstances of your debtor (annual financial statements, municipal or state budgets ) in order to be able to obtain information about the credit risk from these documents. In companies, equity and borrowed capital are brought into relation with one another, because the equity is available as a liability pool for the creditors and therefore the share of equity in the total capital is important. Consequently, the higher the equity ratio, the lower the creditor risk and vice versa. The level of indebtedness should therefore provide information about the ability to survive losses or the short-term withdrawal of equity or debt. It is one of the essential debt ratios .

calculation

First of all, it must be clarified which balance sheet items are to be classified as equity and which as debt capital. Not all items that are formally assigned to equity in the annual financial statements can also be analytically classified as equity for the purpose of determining the level of debt. This also applies to some items that are shown as outside capital in the annual financial statements. Issued convertible bonds or other financing titles are also controversial in their allocation, such as goodwill , which, as an intangible asset, increases equity. If it is not seen analytically as a realizable asset, it must be deducted from equity. This in turn applies to all analytically questionable asset items (such as outstanding capital contributions by the shareholders).

The borrowed capital, which is important for determining the level of indebtedness, is thus composed of provisions (including pension provisions ), convertible bonds (for which the option right was not exercised), other liabilities and half of the special item with a reserve portion. The equity consists of the subscribed capital minus outstanding contributions to it and minus goodwill, plus retained earnings , capital reserve and half of the special item with a reserve portion. Mezzanine capital is to be examined to see whether it is repayable or whether it has subordinated status; Rating agencies count parts of these hybrid forms of financing as economic equity .

A common method of calculating the leverage is:

This key figure is also called the “static leverage”. The higher this level of indebtedness, i.e. the smaller the share of equity in total capital, the greater the risk of loss of wealth for equity investors and creditors . A high proportion of borrowed capital triggers high interest expenses , which either reduce profits or increase losses. This high proportion of debt means that the breakeven point is reached later than with a company with a higher equity ratio .

With the dynamic level of indebtedness , the effective indebtedness (i.e. the outside capital minus the liquid funds) is compared to the cash flow :

This key figure determines the repayment period of the debt based on the freely available cash flow ( debt repayment capacity ) under the assumption that the cash flow can be generated at least at the same level in the future and is used exclusively for debt repayments . Other terms for this metric are debt repayment duration and debt discharge duration. 3 years are considered to be a viable debt repayment period.

consequences

In the case of adequate equity capital, there is also an acceptable level of debt that does not increase risk. “Adequate” equity is an indefinite legal term that aims to relate a company's own funds to its total assets. In any case, in terms of tax law, equity is considered appropriate that is comparable with the capital structure of similar companies in the private sector in the relevant period. According to R 33, Paragraph 2, Clause 3 of the KStR, adequate equity capital is generally given if the equity capital is at least 30% of the assets. With regard to the cited BFH case law, this 30% limit is primarily to be understood as a non-acceptance limit, so that there is no objection to its fulfillment in external tax audits . For taxation purposes, the asset coverage ratio is assumed and the equity is classified as appropriate if the asset coverage ratio (I) is 30% and thus 70% of the fixed assets are to be financed by debt.

The optimal level of indebtedness is considered to be a ratio of equity to debt at which the average cost of capital is the lowest compared to other financing alternatives. A rule of thumb that comes from practice says that the level of indebtedness - depending on the sector - for non-banks should not be higher than 2: 1 (200%), i.e. the borrowed capital should not be more than twice the equity. Similarly, the debt ratio must not exceed 67% of the balance sheet total. As a complementary key figure to the debt capital ratio, this results in the equity ratio , which in the example is 33%.

Taking out loans increases the level of indebtedness and thus also the risk in the company. The higher the level of debt, the more dependent a company becomes on external creditors. A high level of indebtedness from the above formula increases the lender's risks because, in case of doubt, their liability for the assets tied up in equity will not be sufficient to repay the debt in full if the debtor becomes insolvent . A high level of debt usually goes hand in hand with a high level of interest and debt service coverage, because debts trigger interest and repayment payments that have to be financed from the sales process. From the perspective of financial leverage , however, the relatively low equity capital results in a high return on equity ( leverage effect). It is therefore necessary to determine the total return on capital (equity and debt). A high level of indebtedness increases the earnings risks because of the high debt servicing, because more profits are used for interest expenses and thus the break-even point rises with increasing indebtedness ( cost leverage ).

States and municipalities

As debtors, states have completely different economic structures than companies. Structurally, the debt is determined in a similar way to companies and referred to as total debt ( foreign debt only affects national debt to foreign creditors), but this debt must be compared with export earnings or gross domestic product (GDP) for the purpose of determining key figures . The income from export proceeds is primarily available for debt servicing. The GDP, in turn, as a measure of the economic performance of a state within a year, indicates the extent to which the national debt is still in an appropriate relationship to this economic performance.

S is the total national debt, B the GDP. This so-called government debt ratio expresses the ratio of debt to GDP. The Maastricht criteria stipulate a maximum permissible, sanction-free national debt ratio for EMU countries of 60% of GDP ( Art. 126 TFEU). That would mean that three-fifths of the economic output of an entire year would be payable to the creditors of the state to the entire national debt repaid . Of course, currency reserves or new indebtedness can also be used as secondary sources for debt repayment for debt servicing, but these positions are not intended for this purpose. A foreign debt of 150% of export earnings is viewed as a sustainable burden.

The increasing indebtedness of German municipalities in particular has been a topic for years. Here, too, absolute numbers play a subordinate role. The decisive factor is to what extent debt sustainability can still be assumed (see debt service coverage ratio ). For this purpose, the communal debt is compared to the total income (or only own income as a smaller aggregate). Provided that the total income covers the total debt, a reasonable debt sustainability can be assumed.

Effects

The level of indebtedness can be part of bond conditions or loan agreements within the framework of the covenants . In doing so, the debtor undertakes to his creditors not to exceed a certain contractually stipulated upper limit for the degree of indebtedness. If the upper limit is exceeded, there is a breach of contract ( covenant breach ), which initially usually results in a remedy / grace period , which is intended to enable the borrower to subsequently meet the specified key figure. However, if this still does not succeed , a higher credit margin or even an extraordinary termination right of the creditor will be triggered.

See also

Individual evidence

  1. z. B .: Frank Proud: business administration basics: preparation for the European Business Competence * License, EBC * L . Books on Demand GmbH, Norderstedt 2006, ISBN 3-8334-4526-2 .
  2. a b z. B .: Controlling in practice How small and medium-sized companies build an effective reporting system . Gabler Verlag, Wiesbaden 2004, ISBN 978-3-322-89083-2 .
  3. a b Horst-Tilo Beyer: Finanzlexikon. Vahlen, Munich 1971, p. 345.
  4. ^ Fitch Ratings: German Participation Rights - Structures and the Credit Impact for Corporate Issuers. May 10, 2005, p. 5.
  5. ^ Behringer, Stefan .: Corporate controlling . Springer-Verlag Berlin Heidelberg, Berlin, Heidelberg 2011, ISBN 978-3-642-13156-1 .
  6. BFH judgments of September 1, 1982 BStBl. 1983 II, p. 147 and of July 9, 2003 BStBl. 2004 II, p. 425.
  7. Katharine Hoen: Key figures and balance sheet - balance sheet analysis and case study Lenzing AG. 2010, p. 11.