6. Financial leverage ratio or financial risk ratio - the ratio of debt to equity capital.
Kfr = Borrowed capital / Equity capital = (line 590 +690) / 490.
This ratio is considered one of the main indicators of financial stability. The higher its value, the higher the risk of investing capital in a given enterprise; the lower the value of this coefficient, the more stable the financial position of the enterprise.
Kfr shows how many borrowed funds are raised per 1 ruble of own funds.
Kfr (at the beginning of the year) = 575 / 1118 = 0.514
Kfr (at the end of the year) = (25 + 696) / 1374 = 0.525
At the beginning of the year, for every 1 ruble of own funds invested in the assets of the enterprise, 0.51 rubles are borrowed (at the beginning of the year and 0.52 at the end of the year).
The value of the financial risk coefficient depends on:
Share of borrowed capital in total assets;
Shares of fixed capital in total assets;
The ratio of working and fixed capital;
Shares of own and working capital in the formation of current assets;
Shares of own capital in own working capital.
At the analyzed enterprise, changes occurred in the capital structure. The share of equity capital tends to decrease. During the reporting period, it decreased by 0.4 percentage points, since the growth rate of equity capital is lower than the growth rate of borrowed capital. The financial risk ratio increased by 1.04 percentage points. This indicates that the enterprise’s financial dependence on external investors has increased slightly.
Table 4
Calculation of financial stability indicators
| Financial stability ratios | Calculation method | Normal limit | At the beginning of the year | At the end of the year | Deviation | Explanation |
| 1. Ratio of concentration of equity capital (financial independence) | K s.k. = page 490 / page 700 (Own account / Balance currency) | Ks.k. = 0.6, the more the better | 0,66 | 0,656 | -0,004 | Shows what part of assets is formed from own sources of funds |
| 2. Debt capital concentration ratio | To z.k. = line 590 + 690 / line 700 (Borrowed amount / Balance sheet currency) | Kz.k. = 0.4, the smaller the better | 0,34 | 0,344 | 0,004 | Shows what part of assets is formed through borrowed funds of a long-term and short-term nature |
| 3. Financial dependency ratio | Kf.z. = page 700 / page 490 (Balance currency / Own number) | 1,51 | 1,52 | 0,01 | Shows the amount of assets per ruble of equity | |
| 4. Sustainable financing ratio (financial stability) | To u.f. = page 490 + 590 / page 700 (Own Capital + Long-term liabilities) / Balance currency | preferably close to 1 | 0,66 | 0,67 | 0,01 | Determines the share of the enterprise’s assets financed from sustainable sources (III and IV sections of the balance sheet) |
| 5. Equity capital agility ratio | K m. = page 490 - page 190 / page 490 (Own Capital - Non-current assets) / Equity | K m. = 0.5 (from 0 to 1) a growth trend is desirable | 0,515 | 0,419 | -0,096 | Determines the share of equity capital used to finance the current activities of the enterprise |
| 6. Financial leverage (financial risk) ratio | To f.r. = line 590 + 690 / line 490 (borrowed account / own account) | the less the better | 0,514 | 0,525 | 0,01 | Shows how many borrowed funds are raised per 1 ruble. own funds |
The assessment of changes that have occurred in the capital structure may be different from the position of investors and the enterprise. For banks and other creditors, the situation is more reliable if the client's share of equity is high. This eliminates financial risk. Enterprises are interested in attracting borrowed funds for two reasons:
1) interest on servicing borrowed capital is considered as an expense and is not included in taxable profit;
2) interest costs are usually lower than the profit received from the use of borrowed funds in the turnover of the enterprise, as a result of which the return on equity increases.
In a market economy, a large and increasing share of equity capital does not at all mean an improvement in the position of the enterprise or the ability to quickly respond to changes in the business climate. On the contrary, the use of borrowed funds indicates the flexibility of the enterprise, its ability to find loans and repay them, that is, its credibility in the business world.
There are practically no standards for the ratio of borrowed and equity funds, since different industries have different capital turnover.
Each enterprise can determine for itself the standard financial risk ratio:
1. Let’s determine the borrowed capital ratio:
A) find the share of fixed capital in the balance sheet asset and multiply it by 0.25 (798 / 2095 x 0.25 = 0.0952);
B) find the share of working capital in the balance sheet currency and multiply it by 0.5 (1297 / 2095 x 0.5 = 0.3095);
C) add up these results and get the standard value of the borrowed capital of the ZK (0.0952 + 0.3095 = 0.4047 = 0.4);
2. Let’s determine the standard value of the financial risk coefficient:
A) find the standard value of the equity capital of the insurance company (1 – 0.4 = 0.6);
B) find the standard value of the financial risk coefficient: KFR = ZK / SC = 0.4 / 0.6 = 0.67.
If the normative value of the CFR is less than its actual value, then the degree of financial risk is high. In our case, the normative value of KFR = 0.67, and the actual value = 0.52 - this indicates the stability of the enterprise.
Excess or lack of planned sources of funds for the formation of reserves is one of the criteria for assessing the financial stability of an enterprise, according to which 4 types of financial stability are distinguished:
1. Absolute financial stability (inventories are less than the amount of own working capital):
Z (reserves)< СОС (собственные оборотные средства)
This ratio shows that all inventories are fully covered by working capital, i.e. the enterprise does not depend on external sources; this situation is extremely rare.
2. Normal financial stability, in which reserves are greater than own working capital, but less than the planned sources of covering them:
SOS (own working capital)< З (запасы) < ИФЗ (источники финансовых запасов).
IFZ = SOS + line 610 (short-term loans and borrowings) + accounts payable to suppliers and contractors and other creditors.
The above ratio corresponds to the situation when a successfully operating enterprise uses various sources of inventory to purchase inventory.
When an enterprise or company is created, many hope for a long, fruitful and effective existence. But, alas, this does not always happen. And it is necessary to acquire external debts, and sometimes investments are needed. Thus, there is capital that does not belong to the owner of the enterprise. And with it come financial risks. What is it? What does financial risk ratio mean? Why is it considered, how is it interpreted?
What is the financial risk ratio?
To determine the level of potential problems, this indicator is considered. The financial risk coefficient (leverage or attraction) indicates the ratio of finance attracted from external sources to own funds. It is a comparative tool that shows the potential level of freedom in decision-making, income distribution, as well as the possibility of raising additional money for the needs of the enterprise.
Where is it used?
The financial risk coefficient plays an important role in the bond, loan and lending markets. Moreover, it has both uses: it can be used by both an entrepreneur and a potential investor. For the owner of a company, the financial risk coefficient shows the state of the enterprise (and trends in its change - features of development). Also, informing about it is very important from the point of view of future planning.
For an investor, the financial risk coefficient is an indicator of the stability of the enterprise. So, if we consider a company for which it is 0, we can say that everything was fine with it until that moment. But due to some reason or reasons, things got worse, so the company could use a little financial help. But if the financial risk coefficient reaches a value of 1 or even exceeds it, then there are two options:
- Ignore this enterprise as such, which constantly needs finance. help. The situation probably won't change anytime soon.
- Take advantage of the situation by supporting the company. After all, if it does go bankrupt, then the investor will be able to claim production secrets, territory, buildings, equipment as payment of debts. If the enterprise is of significant interest, then such a scheme looks very realistic.
But how do you actually find out the financial risk ratio? And for this it needs to be calculated.
How to calculate the financial risk ratio?
It may seem like a terrible thing to count something. Many economic formulas are a real headache. But not in this case. The financial risk ratio on the balance sheet is one of the simplest. First, let's take a look at the formula and then move on to its explanation.
K fr = ZK/SK
- K fr is the financial risk coefficient.
- ZK is borrowed capital. Anything that was borrowed from a banking institution or invested by an individual legal entity or individual.
- SK is equity capital. This includes all funds that belong to the owner/founder of the enterprise for which the financial risk coefficient is calculated.
Interpretation of the obtained values and application in practice
Now you've calculated the data, got some values - what to do next? What allows us to talk about the financial risk coefficient? The formula has been used and the resulting numbers must now be interpreted. This is required in order to assess the financial stability of the enterprise in case of shocks. The coefficient shows how many units of attracted funds fall on 1 money of your investments. The higher the indicator, the greater the dependence on investors and external debts of the enterprise. The coefficient should be as small as possible. An indicator of less than 0.5 is considered optimal. If the value is 1, the enterprise has significant financial risks, and a number of measures must be taken to correct the current situation.
Conclusion
It should be borne in mind that this coefficient does not mean that the company is about to go bankrupt, even though it can reach values of 2, 3 or 5. It simply indicates that in the event of some problems of capital flight or something like this, the work of the enterprise can significantly stall. For example, you can consider this option: the total capital of the company is 1000 rubles. 200 of them belong to the investor.
If he suddenly withdraws his money, then the remaining 800 will help him survive. But what if the values are changed? It’s unlikely that 200 rubles will be enough for quality work. And it helps to understand the line when you can take money and when you can’t, the financial risk coefficient. Although the balance formula indicates an acceptable line, loans should be treated with caution - after all, someone else’s money is taken, and for a short period of time, and their own is returned, in larger quantities and forever. The optimal action is to reduce the coefficient to zero.
Level of financial risk(degree of financial risk) is the main indicator used to evaluate individual investments. The level of financial risk is determined by the following formula:
UR = VR * RPWhere
UR- level of corresponding financial risk;
VR- the probability of occurrence of this financial risk;
RP- the amount of possible financial losses if this risk materializes.
The financial activity of a company in all its forms is associated with numerous factors, the degree of influence of which on the results of this activity and the level of financial security is increasing significantly at the present time. The risks that accompany the company's business activities and generate financial threats are combined into a special group of financial risks that play the most significant role in the company's overall “risk portfolio.” The level of financial risk of a company has a significant impact on the results of economic activities. The increased level of financial risk recently is due to the instability of the external environment:
- changes in the economic situation in the country;
- emergence of new innovative ones;
- expansion of the scope of financial relations;
- variability and a number of other factors.
Therefore, identification, assessment and monitoring of the level of financial risks are one of the urgent tasks in the practical activities of financial managers.
The level of financial risk is determined by the essence of financial risk itself, which is one of the most complex categories associated with economic activity, which has the following main characteristics:
- Economic nature. Financial risk manifests itself in the sphere of economic activity of an enterprise, is directly related to the formation of its profit and is characterized by possible economic losses in the process of carrying out financial activities. Taking into account the listed economic forms of its manifestation, financial risk is characterized as an economic category, occupying a certain place in the system of economic categories associated with the implementation of the economic process.
- Objectivity of manifestation. Financial risk is an objective phenomenon in the functioning of any enterprise. Risk accompanies almost all types of financial transactions and all areas of financial activity of an enterprise. Although a number of parameters of financial risk depend on subjective management decisions, the objective nature of its manifestation remains unchanged.
- Probability of implementation. The probability of the financial risk category is manifested in the fact that a risk event may or may not occur in the process of carrying out the financial activities of the enterprise. The degree of this probability is determined by the action of both objective and subjective factors, but the probabilistic nature of financial risk is its constant characteristic.
- Uncertainty of consequences. This characteristic of financial risk is determined by the indeterminacy of its financial results, primarily the level of profitability of ongoing financial transactions. The expected level of performance of financial transactions may vary depending on the type of risk level within a fairly significant range. Financial risk can be accompanied by both significant financial losses for the enterprise and the formation of additional income.
- Expected adverse consequences. The consequences of financial risk can be characterized by both negative and positive indicators of financial performance; this risk in business practice is characterized and measured by the level of possible adverse consequences. This is due to the fact that a number of extremely negative consequences of financial risk determine the loss of not only income, but also what leads to it (i.e., to irreversible negative consequences for its activities).
- Level Variability. The level of financial risk inherent in a particular financial transaction or a certain type of financial activity of an enterprise is not constant. First of all, financial risk varies significantly over time, i.e. depends on the duration of the financial transaction, because the time factor has an independent impact on the level of financial risk (manifested through the level of liquidity of invested financial assets, the uncertainty of the movement of the interest rate on the financial market, etc.). In addition, the indicator of the level of financial risk varies significantly under the influence of numerous objective and subjective factors that are in constant dynamics.
- Subjectivity of assessment. Despite the objective nature of financial risk as an economic phenomenon, its main assessment indicator - the level of financial risk - is subjective. This subjectivity, i.e. the unequal assessment of this objective phenomenon is determined by the different level of completeness and reliability of the information base, the qualifications of financial managers, their experience in the field
Where p.1400, page 1500, p.1300- lines of the Balance Sheet (form No. 1).
Financial risk ratio - diagram
Financial risk coefficient - what it shows
Shows the share of the company's equity in assets. The higher this indicator, the greater the entrepreneurial risk of the organization. The higher the share of borrowed funds, the less profit the company will receive, since part of it will be spent on repaying loans and paying interest.
A company, the majority of whose liabilities are borrowed funds, is called financially dependent; the capitalization ratio of such a company will be high. A company that finances its own activities with its own funds is financially independent and has a low capitalization ratio.
This ratio is important for investors considering this company as an investment. They are attracted to companies with a predominance of equity capital. However, the leverage ratio should not be too low, as this will reduce the share of their own profits that they will receive in the form of interest.
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Synonyms
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Let's consider financial risk, its types (credit, market, operational and liquidity risk), modern methods of its assessment and analysis and calculation formulas.
Financial risk of the enterprise. Definition and economic meaning
Financial risk of the enterprise– represents the probability of an unfavorable outcome in which the enterprise loses or receives less than part of its income/capital. Currently, the economic essence of any enterprise is to create income and increase its market value for shareholders/investors. Financial risks are basic in influencing the results of the financial and economic activities of an enterprise.
And in order for an enterprise to reduce the negative impact of financial risks, methods for assessing and managing its size are being developed. The basic premise put forward by Norton and Kaplan that underlies risk management is that only what can be quantified can be managed. If we cannot measure or quantify any economic process, we will not be able to manage it.
Financial risk of an enterprise: types and classification
The process of any analysis and management consists of identifying and classifying existing risks of an investment project/enterprise/assets, etc. In the article we will place greater emphasis on assessing the financial risks of an enterprise, but many of the risks are also present in other economic entities. Therefore, the initial task for every risk manager is to formulate threats and risks. Let us consider the main types of financial risks that are identified in the practice of financial analysis.
| Types of financial risks | Description of types of risk |
| Credit risk (Credit Risk) | Assessment of credit risk by calculating the probability of non-fulfillment of counterparties’ obligations towards the lender to pay interest on the loan. Credit risk includes the creditworthiness and risk of bankruptcy of the enterprise/borrower |
| Operational risk (Operationrisk) | Unforeseen company losses due to technical errors and failures, intentional and accidental personnel errors |
| Liquidity risk (Liquidityrisk) | The solvency of an enterprise is the inability to pay in full to borrowers using cash and assets |
| Market risk (Marketrisk) | The likelihood of a negative change in the market value of the enterprise’s assets as a result of the influence of various macro, meso and micro factors (interest rates of the Central Bank of the Russian Federation, exchange rates, cost, etc.) |
General approaches to assessing financial risks
All approaches to assessing financial risks can be divided into three large groups:
- Estimation of probability of occurrence. Financial risk as the likelihood of an unfavorable outcome, loss or damage.
- Assessment of possible losses under one or another scenario for the development of the situation. Financial risk as the absolute size of losses possible adverse event.
- Combined approach. Financial risk assessment, how the probability of occurrence and the size of losses.
In practice, a combined approach is most often used, because it gives not only the probability of risk occurrence, but also possible damage to the financial and economic activities of the enterprise, expressed in monetary terms.
Algorithm for assessing the financial risks of an enterprise
Let's consider a standard algorithm for assessing financial risks, which consists of three parts. Firstly, analysis of all possible financial risks and selection of the most significant risks that can have a significant impact on the financial and economic activities of the organization. Secondly, a method for calculating a particular financial risk is determined, which allows the threat to be formalized quantitatively/qualitatively. At the last stage, changes in the size of losses/probability are predicted under various enterprise development scenarios, and management decisions are developed to minimize negative consequences.
The influence of financial risks on the investment attractiveness of an enterprise
The investment attractiveness of an enterprise is a combination of all indicators that determine the financial condition of the enterprise. Increasing investment attractiveness allows you to attract additional funds/capital to increase technological, innovative, personnel, and production potential. An integral indicator of investment attractiveness is the criterion of economic added value EVA (EconomicValueAdded), which shows the absolute excess of operating profit over the cost of investment capital. This indicator is one of the key indicators in the strategic management system of the enterprise - in the cost management system (VBM, Value Based Management). The formula for calculating economic added value is as follows:
EVA (Economic Value Added)– indicator of economic added value, reflecting the investment attractiveness of the enterprise;
NOPAT (Net Operating Profit Adjusted Taxes)– profit from operating activities after taxes, but before interest payments;
WACC (Weight Average Cost of Capital)– an indicator of the weighted average cost of capital of an enterprise. And it is calculated as the rate of return that the owner of the enterprise plans to receive on invested own and borrowed capital;
C.E. (Capital Employed)– used capital, which is equal to the sum of permanent assets and working capital involved in the activities of the enterprise (FixedAssets +WorkingCapital).
Since the weighted average cost of capital of an enterprise consists of the cost of borrowed and equity capital, reducing the financial risks of an enterprise makes it possible to reduce the cost of borrowed capital (interest rates on loans), thereby increasing the value of economic value added (EVA) and the investment attractiveness of the enterprise. The figure below shows a diagram of financial risk management and investment attractiveness.
Methods for assessing financial risks
In order to manage risks, they need to be assessed (measured). Let's consider the classification of methods for assessing the financial risks of an enterprise, highlight their advantages and disadvantages, presented in the table below. All methods can be divided into two large groups.
So, let us examine in more detail quantitative methods for assessing the financial risks of an enterprise.
Methods for assessing enterprise credit risks
A component of the financial risk of an enterprise is credit risk. Credit risk is associated with the possibility of an enterprise not paying its obligations/debts on time and in full. This property of an enterprise is also called creditworthiness. The extreme stage of loss of creditworthiness is called bankruptcy risk, when a company cannot completely repay its obligations. Methods for assessing credit risk include the following econometric risk diagnostic models:
Assessment of credit risks using the E. Altman model
The Altman model allows you to assess the risk of bankruptcy of an enterprise/company or a decrease in its creditworthiness based on the discriminant model presented below:
Z – the final indicator for assessing the credit risk of an enterprise/company;
K 1 – own working capital/amount of assets;
K 2 – net profit/total assets;
K 3 – profit before tax and interest payments/total assets;
K 4 – market value of shares/borrowed capital;
K 5 – revenue/total assets.
To assess a company's credit risk, it is necessary to compare the resulting indicator with the risk levels presented in the table below.
It should be noted that this model can only be applied to enterprises that have ordinary shares on the stock market, which makes it possible to adequately calculate the K4 indicator. A decrease in creditworthiness increases the total financial risk of the company.
Credit risk assessment using R. Taffler's model
The next model for assessing the credit risks of an enterprise/company is the R. Taffler model, the calculation formula of which is as follows:
Z Taffler – assessment of the credit risk of an enterprise/company;
K 1 – indicator of enterprise profitability (profit before tax/current liabilities;
K 2 – indicator of the state of working capital (current assets/total liabilities);
K 3 – financial risk of the enterprise (long-term liabilities/total assets);
K 4 – liquidity ratio (sales revenue/total assets).
The resulting credit risk value must be compared with the risk level presented in the table below.
| Taffler criterion | |
| >0,3 | Low risk |
| 0,3 – 0,2 | Moderate risk |
| <0,2 | High risk |
Assessment of credit risks using the R. Lees model
In 1972, economist R. Lees proposed a model for assessing credit risks for UK enterprises, the calculation formula of which is as follows:
K 1 – working capital/amount of assets;
K 2 – profit from sales / amount of assets;
K 3 – retained earnings / amount of assets;
K 4 – equity capital / borrowed capital.
In order to determine the level of credit risk, it is necessary to compare the calculated Lis criterion with the level of risk presented in the table below.
| Fox criterion | Credit risk (probability of bankruptcy) |
| >0,037 | Low risk |
| <0,37 | High level of risk |
Methods for assessing operational risks
One type of financial risk is operational risks. Let's consider a method for assessing operational risks for companies in the banking sector. According to the basic method ( BIA) operational risk assessments ( Operational Risk Capital,ORC) the financial institution calculates the reserve that should be allocated annually to cover this risk. So in the banking sector a risk of 15% is taken, that is, every year banks must reserve 15% of the average annual gross income ( GrossIncome,G.I.) over the past three years. The formula for calculating operational risk for banks will be as follows:
Operational risk= α x (Average gross income);
α – coefficient established by the Basel Committee;
GI is the average gross income for each type of bank activity.
Standardized methodology for assessing operational risksT.S.A.
A complication of the BIA method is the TS method, which calculates deductions for operational risks arising in various functional areas of the bank’s activities. To assess operational risks, it is necessary to highlight the areas where they may arise and the nature of the impact on financial activities they will have. Let's look at an example of assessing a bank's operational risks.
| Functional activities of the bank | Deduction rate |
| Corporate finance(providing banking services to clients, government agencies, enterprises in the capital market) | 18% |
| Trade and sale(transactions on the stock market, purchase and sale of securities) | 18% |
| Banking services for individuals persons(services to individuals, provision of loans and credits, consulting, etc.) | 12% |
| Banking services for legal entities | 15% |
| Payments and transfers(carrying out settlements on accounts) | 18% |
| Agency services | 15% |
| Asset Management(management of securities, cash and real estate) | 12% |
| Brokerage activities | 12% |
As a result, the amount of the final deduction will be equal to the amount of deductions for each allocated function of the bank.
It should be noted that, as a rule, operational risks are considered for companies in the banking sector, and not in the industrial or manufacturing sector. The fact is that most operational risks arise from human error.
Methodology for assessing liquidity risk
The next type of financial risk is the risk of loss of liquidity, which shows the inability of an enterprise/company to repay its obligations to creditors and borrowers on time. This ability is also called the solvency of the enterprise. In contrast to creditworthiness, solvency takes into account the possibility of repaying debt not only with cash and quickly liquid assets, but also with medium-liquid and low-liquid assets.
To assess liquidity risk, it is necessary to evaluate and compare with the standards the basic liquidity ratios of the enterprise: current liquidity ratio, absolute liquidity ratio and quick liquidity ratio.
Formulas for calculating enterprise liquidity ratios
Analysis of various liquidity ratios shows the ability of an enterprise to repay its debt obligations using various three types of assets: quick-liquid, medium-liquid and low-liquid.
Methodology for assessing market risk – VAR
The next type of financial risk is market risk, which is a negative change in the value of an enterprise/company’s assets as a result of changes in various external factors (industry, macroeconomic and microeconomic). For quantitative assessment of market risks, the following methods can be distinguished:
- VaR method (Value at Risk).
- Shortfall method (Shortfall at Risk).
Risk assessment methodVaR
The VAR method is used to assess market risk (Value at Risk), which allows you to estimate the probability and size of losses in the event of a negative change in the value of the company on the stock market. The calculation formula is as follows:
Where:
V – current value of shares of the company/enterprise;
λ – quantile of the normal distribution of returns on company/enterprise shares;
σ – change in the profitability of the company/enterprise shares, reflecting the risk factor.
A decrease in the value of shares leads to a decrease in the company's market capitalization and a decrease in its market value, and consequently, its investment attractiveness. You can learn more about how to calculate the VaR risk measure in Excel in my article: “ “.
Risk assessment methodShortfall
Shortfall market risk assessment method (analogue:Expected Shorfall, Average value at risk, Conditional VaR) more conservative than the VaR method. The risk assessment formula is as follows:
α – selected risk level. For example, these could be values 0.99, 0.95.
The Shortfall method better reflects the “heavy tails” in the distribution of stock returns.
Resume
In this article, we examined various methods and approaches to assessing the financial risks of an enterprise/company: credit risk, market risk, operational risk and liquidity risk. In order to manage risk, it is necessary to measure it; this is a basic postulate of risk management. Financial risk is a complex concept, therefore, assessing various types of risk allows us to weigh possible threats and develop a set of measures to eliminate them.
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