Leverage is defined in physics as “the mechanical advantage or power gained by using a lever.” In finance it is “the use of long-term borrowed money in an attempt to increase your return to shareholder.” So when do you know when leverage is good, bad or…?

In the financial world…

Leverage is good when:

  • you borrow the right amount of money
  • at the right terms
  • invest the funds in the right projects to grow your firm
  • this achieves the returns you forecast
  • you repay the debt as agreed & the remainder goes to increase the return to shareholders

Leverage is bad when:

  • you borrow too much money
  • you borrow to little money
  • the terms are excessive
  • you choose projects that end up missing projections
  • the results fall significantly short of forecasts
  • you can’t repay the debt & must default

Leverage is neither when:

  • you can’t locate financing at rates you’re willing to pay
  • terms in the marketplace are not conducive to positive returns
  • you don’t have enough “good” projects to warrant investing capital
  • there are too many unknowns to be comfortable in taking on the risk

Leverage can give you significant benefits when used properly and tremendous problems when not. Smart firms analyze their options when it comes to using leverage & makes the best informed decisions. *

To dig a little deeper, I will explore operating leverage and compare it to financial leverage in future blogs. Look for this.

* If you want more details on how to make the most of leverage in your firm pleased contact me at dsfeiman@BuildItBackwards.com

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