Leverage is a concept that is used in many industries and tasks. You leverage a longer wrench to loosen a tight bolt, and you can leverage your authority to get your kids to do what you want them to do. However, in business, leverage typically deals with money. These are some things you should know about leverage in the business.
Typically, businesses leverage their assets, money or loans to pursue business growth. If a company borrows money or gains money through others’ investments it is said to be leveraged. Consider your home mortgage. The bank would not have granted you the mortgage if your home was worth less than the loan. This is similar to a business loan, where the company’s assets are evaluated to determine whether or not it is approved.
Using Leverage for Growth
When you first start a company or want to pursue an expansion plan, you may not have the cash on hand to purchase everything necessary to achieve your goals. For example, if you open a retail store, you need to purchase shelving, equipment, fixtures and product. You may also have to pay for building renovations. If you purchase a building, you will need additional funding. In growth situations, you may need to expand your raw materials purchases, add equipment and hire more staff.
These expenses could put a drain on your cash flow, which could prevent you from paying your monthly obligations. Therefore, you may consider securing investors or a bank loan for these expenses, relieving the drain on your incoming revenue.
Using Leverage for Buyouts
You can also purchase a company using borrowed or invested money. This is called a leveraged buyout. The business assets you purchase serve as collateral for your financing. The bank assumes that these assets will be used immediately to produce cash or income. The expectation is that the cash flows will be strong since the original company is already established.
Leverage Can Be Positive or Negative
If your company has too much debt, or is too highly leveraged, you can face defaults on your expenses or loans. However, the type of debt can impact whether you are likely to default. For example, if your suppliers offer financing, these debts tend to be smaller, making them easier to pay back. Long-term debts, such as equipment loans and mortgages, have higher payments and longer pay-back periods, so they can affect your cash flow for longer periods of time.
As you search for business growth strategies, you may consider leveraging your assets, but set a reasonable rate so you don’t overleverage your company.