LEVERAGE: PROS AND CONS | TWELVE GRAINS CAPITAL

Описание: Financial leverage is also known as trading on equity or simply leverage. It’s when you use debt (borrowed money) to purchase assets because you expect the asset to generate income or rise in value. The greater the debt, the greater the leverage. As leverage goes up, so does the risk of failure as it becomes more difficult to repay the debt.

PROS
Leverage is a great way for companies to acquire or buy out other companies or buy back equity. These events have specific growth objective. Once the objective is complete, the company should generate more income than the cost of the debt (if the managers did their homework well.)

Companies often use financial leverage to finance assets to avoid issuing stock to raise capital. This increases shareholder value because 1) the company has more assets, and 2) the value of stock isn’t diluted by the existence of more stock.

CONS
Financial leverage can also amplify your losses when the value of the asset falls. If the value falls far enough, it may be worth less than your loan. This means you would be stuck with debt even if you sold the asset.

Financial leverage can be especially risky in businesses with low barriers to entry or cyclical sales cycles. In both of these cases, profits can fluctuate wildly from year to year, or even in the same year. This makes it hard to pay back loans consistently and increases the odds of default.

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