Every enterprise develops the activity using both equity and borrowed capital, different one by the  other through the generated/engendered costs.
The financial risk determines the variability of result indicators, thanks to the financial structure of enterprise modification.
Due the lack of own resources, in order to  activity development, the enterprise uses the loans in order to achieve the oportunity of one investment

Caruntu, Genu Alexandru

Romanescu, Marcel Laurentiu

Munich Personal RePEc Archive

MPRA
Munich Personal RePEc Archive
Financial Risk Part of Efficiency Rate
Variation Related to Equity
Genu Alexandru Caruntu and Marcel Laurentiu Romanescu
University of Constantin Brancusi Targu Jiu, Romania
8. October 2008
Online at http://mpra.ub.uni-muenchen.de/11601/
MPRA Paper No. 11601, posted 16. November 2008 05:29 UTC
FINANCIAL RISK PART OF  EFFICIENCY RATE VARIATION RELATED TO 
EQUITY  
 
Căruntu Genu Alexandru – Lect. Univ. dr. 
Universitatea Constantin Brâncuşi Tg-Jiu 
Romanescu Marcel Laurenţiu – Lect. Univ. dr.  
Universitatea Constantin Brâncuşi Tg-Jiu 
 
 
Abstract 
 Every enterprise develops the activity using both equity and borrowed capital, 
different one by the  other through the generated/engendered costs. 
  The financial risk determines the variability of result indicators, thanks to the 
financial structure of enterprise modification1. 
 Due the lack of own resources, in order to  activity development, the enterprise 
uses the loans in order to achieve the oportunity of one investment. 
 
Keywords: financial risk, interest, debts, equity, interest ratio, capital 
 
 An  enterprise which  appeals to loans must to endure from the results also the 
financial expenses afferent to the respective loan. Due this fact, indebting/obliging , 
through it dimensions and cost, determine  the results modifications, therefore modify the 
financial risk.  
 To an enterprise level, the investment decision generates the economical activity 
risk(by increasing of fixed costs) , and the financing decision generates the financial risk  
 The financial risk takes into account also the influence of capital's structure, 
respectively the indebting degree of one economic agent. 
 If for a certain capital  need, the financial expenses( interest) are fixed expenses, 
then the financial risk could be evaluate through a global rentability threshold, as the 
following formula2: 
 
                                     
CA
CV
DobCF
RF
−
+=
1
 or 
Rmcv
DobCF
RF
+=    
Consisting of : 
 CA- sales/turnover ; 
 CF-  fixed expenses ; 
 Dob- interest ; 
 CV – variable expenses ; 
Rmcv – variable expenses margin rate; 
                                                 
1Popa I. E.,  Financial-accounting mechanism of provisions , Risoprint P.H, Cluj-Napoca, 2003, page. 82.  
2 Căruntu C., Tănăsoiu G., Căruntu G., Financial management.Theory and applications, Academica 
Brâncuşi P.H, Tg-Jiu, 2003, page. 134. 
 The financial risk's evaluation are made simillarious to the exploiting risk, with 
the helping of the following indicators  : 
• the safety margin; 
• the safety index; 
• the elasticity coefficient. 
 If it modifies the return of equity, the analysis of this modification due the 
financial policy could be pursuit with the aid of a model entitled “financial leverage 
effect “3. 
 The  financial leverage measures the impact of credit's quantization (in order to 
finance an investment) over its financial rentability. 
  The financial leverage effect, namely the variation of equity return depends on 
the correlations which exist between the return of assets  and the debt cost or interest rate,  
on a side and the debt level on the other side. 
 Starting from balance sheet structure, respectively the rentability rates presented 
in figure no.1 could be illustrate the computation modalities of financial rentability 
starting from the economical rentability, accentuate, same time the influence of “leverage 
effect ”4. 
 
Cpr                                
(rf) 
 
Ae 
(re) 
 Dat                      
(rd) 
 
 
Figure 1.  Accounting Balancesheet and the appropriate rentability rates  
        
 Consisting of: 
Ae= economic active ; 
 re=assets return; 
Cpr=equity ; 
rf = financial rentability rate ; 
Dat=debts ; 
rd=interest. 
  
 If the economical agent analised is profit taxation exempt , then the exercise result 
(Rex) could be determine as difference between the exploiting result (Rex) and the interest 
(Dob) payed for the borrowed capital  (Dat): 
Rex = RE – Dob 
  
The exploiting result is obtained from the calculation relation of assets return ( re): 
 
                                                 
3H. Cristea, M. Pirtea, C. Enache, Establishment of enterprise's financial situation .Studies  and problems. 
Mirton P.H , Timisoara, 2000, page. 58.  
4 Căruntu C., Tănăsoiu G., Căruntu G., Financial management . Theory and applications, Academica 
Brâncuşi P.H, Tg-Jiu, 2003, page. 138. 
ereARE
eA
RE
er ×=⇒=  
  
If all these dates are replaced in the calculation relation of financial return, will be 
obtaining the following formula : 
 
prC
rDat dreeA
prC
DobRE
C pr
exR
fr
×−×=−==  
  
 It si remarked that the economic active is entirely finanaced from the equity and 
the lended/borrowed capital (Ae=Cpr + Dat). In this case the foregoing relation will 
become: 
 ( ) ( )
prC
Dat
drerer
prC
drprCerDatprC
fr −+=
×−×−=  
 
 It is considered the following relationship on which will be build the following 
relation : 
                                        
      Vf +Vex  - I mp =0 
    Cf = Dob 
 
Consisting of  :  
Vf, Vex –  financial incomes ,respectively  extraordinary incomes ; 
Cf , Cex –  financial expenses , respectively  exceptional expenses ; 
Imp –  profit tax . 
   
 If in the mentioned relationship are introduced the profit tax rate (t) then the 
financial rentability rate becomes : 
 
( ) ( )tC
Dat
rrrr
pr
deef −⎥⎥⎦
⎤
⎢⎢⎣
⎡
−+= 1  
  
 The indebting rate,as it is known under the title of  leverage rate illustrates the 
influence  which indebting detains over the equity rate of enterprise. 
  In financial theory are made the distinction between the rate of equity named also 
the financial rentability ratio5. 
                                                 
5 Ion Stancu, Finance, financial market and securities administration. Real investments and its financing. 
Analysis and financial administration of enterprise .  The 3 rd edition  Economic P.H , Bucharest, 
2002.page. 107. 
 Computed on the enterprise's capital basis, the financial rentability ratio could be 
describe through the following formula: 
 ( ) ( )
( ) ( )drGrK
drK
K
KdKKr
K
KidKrr
e
p
ei
p
ipie
p
te
f
−=+−
=⋅−+=⋅−⋅
 
 
Consisting of :   
Kt-   total capital; 
Ki-   borrowed capital; 
Kp-  equity; 
d -   interest ratio 
G=K-Kp 
G-  indebting ratio 
 
Thereby if : 
 1. rf<1 – the leverage effect acts unfavourable, the economic rentability /return of 
assets beeing lower then the debt cost, thereby the equity rentability decreases when the 
enterprises increase the indebting rate; 
 2. rf=1 – the indebting course don't modify the equity rentability; 
 3. rf>1 – the leverage effect acts on enterprise's advantage, the rentability is an 
increasing function of leverage ratio, the enterprise beeing able to improve their 
rentability by increasing the indebting ratio; 
4. a decreasing of activity amplifies the loss of one indebting society, the 
finanacila expenses beeing without elasticity. Therefore are settled a connection between 
the exploiting risk and the indebting risk ; 
In  the case of one enterprises which cumullates profit, the indebting cost must be 
computed after taxation, thanks to the fact that financial expenses are deducitilited from 
the taxation basis and will generate tax savings. An enterprise which registered loss , 
can't deduct the financial expenses, it beares entirely the indebting cost. 
 The condition that financial rentability to increase when the enterprise appeals to 
debts is that return of asstes to be higher then the interest rate. in this case, the financial 
rentability ratio is lower then the interest ratio, then the leverage effect becomes negative 
and the financial ratio will be smaller then the assets return, as the indebting ratio is 
higher. 
 Un economic agent could be in one of these three situations : 
1. re>rd – thereby the credits using will conduct to assets return ratio 
improvement ; 
2. re=rd –  credits using has no influence from leverage effect point of view; 
3. re<rd –  credits using will conduct to performances reduction. 
 The influence factors on the financial rentability ratio are the assets return ratio 
and the leverage effect. 
 Beside these indicators  occur other factors, such as : 
• total aseets turnover  
eA
CA
; 
•  commercial rentability ratio 
CA
RE ; 
• difference between the assets return ratio and the interest ratio (re-rd); 
• indebting ratio of  enterprise  ⋅
prC
Dat
.  
A lot of economic agents frenzy look for the certitude and risks elimination, 
without taking into account the fact that future has not certitude, can't be known from 
before and in fact must to resist to risks.        
In order to allow enterprise to be able to enter obligations is necessary to establish 
a diagnosis of financial situations when are ilustrated the strong points and the faible 
points of financial administration.  
The pursuit  objective is to  detect  eventually financial lack and to adopt new 
administration decision of enterprise. 
 These  decisions are based on the origin's identification and the lack of poise's 
cause, on one part , and on the other side to establishment the measures to fix the balance 
lack, also the enterprise's capacity to respect/honour the obligations, on long or short  
term( liquidity and enterprise's solvency) and the enterprise's value.  
In order to improve the financial performances, the enterprise must to accelerate 
the assets turnover, to increase the commercial rentability and to substantiate the financial 
policy which could afford to make available the favorable conjunctures. 6
 
BIBLIOGRAPHY: 
 
1. Căruntu C., Tănăsoiu G., Căruntu G., Financial management . Theory and applications, 
Academica Brâncuşi P.H, Tg-Jiu, 2003 
2.H. Cristea, M. Pirtea, C. Enache, Establishment of enterprise's financial 
situation.Studies  and problems. Mirton P.H , Timisoara, 2000 
3. Isfanescu A., Robu V., Anghel I., Enterprise's evaluation, Economic Tribune P.H, 
Bucharest, 2001 
4. Popa I. E., Financial-accounting mechanism of provisions , Risoprint P.H, Cluj-
Napoca, 2003  
5. Ion Stancu, Finance, financial market and securities administration. Real investments 
and their financing. Analysis and financial administration of enterprise .  The 3 rd edition  
Economic P.H , Bucharest, 2002.page. 107. 
 
 
 
                                                 
6 Aurel Isfanescu, Vasile Robu, Ion  Anghel, Enterprise's evaluation, Economic Tribune P.H, Bucharest, 
2001,page.113 
 


Financial Risk Part of Efficiency Rate Variation Related to Equity

Munich RePEc Personal Archive

MPRAMunich Personal RePEc ArchiveFinancial Risk Part of Efficiency RateVariation Related to EquityGenu Alexandru Caruntu and Marcel Laurentiu RomanescuUniversity of Constantin Brancusi Targu Jiu, Romania8. October 2008Online at http://mpra.ub.uni-muenchen.de/11601/MPRA Paper No. 11601, posted 16. November 2008 05:29 UTCFINANCIAL RISK PART OF  EFFICIENCY RATE VARIATION RELATED TO EQUITY   Căruntu Genu Alexandru – Lect. Univ. dr. Universitatea Constantin Brâncuşi Tg-Jiu Romanescu Marcel Laurenţiu – Lect. Univ. dr.  Universitatea Constantin Brâncuşi Tg-Jiu   Abstract  Every enterprise develops the activity using both equity and borrowed capital, different one by the  other through the generated/engendered costs.   The financial risk determines the variability of result indicators, thanks to the financial structure of enterprise modification1.  Due the lack of own resources, in order to  activity development, the enterprise uses the loans in order to achieve the oportunity of one investment.  Keywords: financial risk, interest, debts, equity, interest ratio, capital   An  enterprise which  appeals to loans must to endure from the results also the financial expenses afferent to the respective loan. Due this fact, indebting/obliging , through it dimensions and cost, determine  the results modifications, therefore modify the financial risk.   To an enterprise level, the investment decision generates the economical activity risk(by increasing of fixed costs) , and the financing decision generates the financial risk   The financial risk takes into account also the influence of capital's structure, respectively the indebting degree of one economic agent.  If for a certain capital  need, the financial expenses( interest) are fixed expenses, then the financial risk could be evaluate through a global rentability threshold, as the following formula2:                                       CACVDobCFRF−+=1 or RmcvDobCFRF+=    Consisting of :  CA- sales/turnover ;  CF-  fixed expenses ;  Dob- interest ;  CV – variable expenses ; Rmcv – variable expenses margin rate;                                                  1Popa I. E.,  Financial-accounting mechanism of provisions , Risoprint P.H, Cluj-Napoca, 2003, page. 82.  2 Căruntu C., Tănăsoiu G., Căruntu G., Financial management.Theory and applications, Academica Brâncuşi P.H, Tg-Jiu, 2003, page. 134.  The financial risk's evaluation are made simillarious to the exploiting risk, with the helping of the following indicators  : • the safety margin; • the safety index; • the elasticity coefficient.  If it modifies the return of equity, the analysis of this modification due the financial policy could be pursuit with the aid of a model entitled “financial leverage effect “3.  The  financial leverage measures the impact of credit's quantization (in order to finance an investment) over its financial rentability.   The financial leverage effect, namely the variation of equity return depends on the correlations which exist between the return of assets  and the debt cost or interest rate,  on a side and the debt level on the other side.  Starting from balance sheet structure, respectively the rentability rates presented in figure no.1 could be illustrate the computation modalities of financial rentability starting from the economical rentability, accentuate, same time the influence of “leverage effect ”4.  Cpr                                (rf)  Ae (re)  Dat                      (rd)   Figure 1.  Accounting Balancesheet and the appropriate rentability rates           Consisting of: Ae= economic active ;  re=assets return; Cpr=equity ; rf = financial rentability rate ; Dat=debts ; rd=interest.    If the economical agent analised is profit taxation exempt , then the exercise result (Rex) could be determine as difference between the exploiting result (Rex) and the interest (Dob) payed for the borrowed capital  (Dat): Rex = RE – Dob   The exploiting result is obtained from the calculation relation of assets return ( re):                                                   3H. Cristea, M. Pirtea, C. Enache, Establishment of enterprise's financial situation .Studies  and problems. Mirton P.H , Timisoara, 2000, page. 58.  4 Căruntu C., Tănăsoiu G., Căruntu G., Financial management . Theory and applications, Academica Brâncuşi P.H, Tg-Jiu, 2003, page. 138. ereAREeAREer ×=⇒=    If all these dates are replaced in the calculation relation of financial return, will be obtaining the following formula :  prCrDat dreeAprCDobREC prexRfr×−×=−==     It si remarked that the economic active is entirely finanaced from the equity and the lended/borrowed capital (Ae=Cpr + Dat). In this case the foregoing relation will become:  ( ) ( )prCDatdrererprCdrprCerDatprCfr −+=×−×−=    It is considered the following relationship on which will be build the following relation :                                               Vf +Vex  - I mp =0     Cf = Dob  Consisting of  :  Vf, Vex –  financial incomes ,respectively  extraordinary incomes ; Cf , Cex –  financial expenses , respectively  exceptional expenses ; Imp –  profit tax .     If in the mentioned relationship are introduced the profit tax rate (t) then the financial rentability rate becomes :  ( ) ( )tCDatrrrrprdeef −⎥⎥⎦⎤⎢⎢⎣⎡−+= 1     The indebting rate,as it is known under the title of  leverage rate illustrates the influence  which indebting detains over the equity rate of enterprise.   In financial theory are made the distinction between the rate of equity named also the financial rentability ratio5.                                                  5 Ion Stancu, Finance, financial market and securities administration. Real investments and its financing. Analysis and financial administration of enterprise .  The 3 rd edition  Economic P.H , Bucharest, 2002.page. 107.  Computed on the enterprise's capital basis, the financial rentability ratio could be describe through the following formula:  ( ) ( )( ) ( )drGrKdrKKKdKKrKKidKrrepeipipieptef−=+−=⋅−+=⋅−⋅  Consisting of :   Kt-   total capital; Ki-   borrowed capital; Kp-  equity; d -   interest ratio G=K-Kp G-  indebting ratio  Thereby if :  1. rf<1 – the leverage effect acts unfavourable, the economic rentability /return of assets beeing lower then the debt cost, thereby the equity rentability decreases when the enterprises increase the indebting rate;  2. rf=1 – the indebting course don't modify the equity rentability;  3. rf>1 – the leverage effect acts on enterprise's advantage, the rentability is an increasing function of leverage ratio, the enterprise beeing able to improve their rentability by increasing the indebting ratio; 4. a decreasing of activity amplifies the loss of one indebting society, the finanacila expenses beeing without elasticity. Therefore are settled a connection between the exploiting risk and the indebting risk ; In  the case of one enterprises which cumullates profit, the indebting cost must be computed after taxation, thanks to the fact that financial expenses are deducitilited from the taxation basis and will generate tax savings. An enterprise which registered loss , can't deduct the financial expenses, it beares entirely the indebting cost.  The condition that financial rentability to increase when the enterprise appeals to debts is that return of asstes to be higher then the interest rate. in this case, the financial rentability ratio is lower then the interest ratio, then the leverage effect becomes negative and the financial ratio will be smaller then the assets return, as the indebting ratio is higher.  Un economic agent could be in one of these three situations : 1. re>rd – thereby the credits using will conduct to assets return ratio improvement ; 2. re=rd –  credits using has no influence from leverage effect point of view; 3. re<rd –  credits using will conduct to performances reduction.  The influence factors on the financial rentability ratio are the assets return ratio and the leverage effect.  Beside these indicators  occur other factors, such as : • total aseets turnover  eACA; •  commercial rentability ratio CARE ; • difference between the assets return ratio and the interest ratio (re-rd); • indebting ratio of  enterprise  ⋅prCDat.  A lot of economic agents frenzy look for the certitude and risks elimination, without taking into account the fact that future has not certitude, can't be known from before and in fact must to resist to risks.        In order to allow enterprise to be able to enter obligations is necessary to establish a diagnosis of financial situations when are ilustrated the strong points and the faible points of financial administration.  The pursuit  objective is to  detect  eventually financial lack and to adopt new administration decision of enterprise.  These  decisions are based on the origin's identification and the lack of poise's cause, on one part , and on the other side to establishment the measures to fix the balance lack, also the enterprise's capacity to respect/honour the obligations, on long or short  term( liquidity and enterprise's solvency) and the enterprise's value.  In order to improve the financial performances, the enterprise must to accelerate the assets turnover, to increase the commercial rentability and to substantiate the financial policy which could afford to make available the favorable conjunctures. 6 BIBLIOGRAPHY:  1. Căruntu C., Tănăsoiu G., Căruntu G., Financial management . Theory and applications, Academica Brâncuşi P.H, Tg-Jiu, 2003 2.H. Cristea, M. Pirtea, C. Enache, Establishment of enterprise's financial situation.Studies  and problems. Mirton P.H , Timisoara, 2000 3. Isfanescu A., Robu V., Anghel I., Enterprise's evaluation, Economic Tribune P.H, Bucharest, 2001 4. Popa I. E., Financial-accounting mechanism of provisions , Risoprint P.H, Cluj-Napoca, 2003  5. Ion Stancu, Finance, financial market and securities administration. Real investments and their financing. Analysis and financial administration of enterprise .  The 3 rd edition  Economic P.H , Bucharest, 2002.page. 107.                                                     6 Aurel Isfanescu, Vasile Robu, Ion  Anghel, Enterprise's evaluation, Economic Tribune P.H, Bucharest, 2001,page.113  

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Financial Risk Part of Efficiency Rate Variation Related to Equity

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