Which Entrepreneur doesn’t want to expand Inorganically (in exponential terms)??? Leverage gives the power of managing large assets with less owned capital.
Moreover, the formula of ROE explains the importance of leverage
But, what’s Leverage? In, simple terms, addition of ‘Others’ Money’ in the organisation for meeting Fund requirement.
- Business acquisition / expansion with less net worth
- Asset Acquisition (may be non-productive)
- Increase in Liquidity
- Improved Working Capital (‘Current Assets’ Less ‘Current Liabilities’)
- More funds for Producing More
- Better Liquidity for Branding / Brand awareness
- New Market Penetration
- In less time, turning dreams into reality
EVERYTHING ROSY ABOUT LEVERAGE, BUT WATCH OUT FOR RISKS ALSO
Leverage increases the risk since it brings (depending upon structure of leverage):
- Regular payment of Installments / Interest
- Chances of defaults in repayments
- Tendency to acquire unproductive Assets, which do not give any returns
- Mismatch in Cash-flow (Returns may come in medium to long-term while repayment may start earlier)
- Chances of incurring Wasteful Expenditure
After-all, Debt needs to be repaid alongwith Interest as per terms & conditions of the debt. Defaults risk the organisation’s sustainability. Organisation gets unfavorable terms from lenders after committing defaults.
Therefore, Plan Leverage:
- Carefully calculate returns from existing business
- Scrutinize the returns from New Acquisition and its Sustainability over the term of debts
- Consider the returns in Worst Scenario
- Create Buffer to avoid defaults