Financial Leverage is financing a company with other people's money.
Benefits: (profitability) The return for the entrepreneur can be greater because his/her money is not tied to the business. With a highly leveraged business the owner equity is small, as the debt is paid the return can yield a very high Profitability ratio.
Deficits: (loss) In order to pay the interest on
the leverage, the owner may have to raise prices, in a highly competitive
market, this may result in lower sales. If the competition is Equity Financed
they may be able to lower prices, resulting in a LOSS or even bankruptcy.
Fixed Costs are interest paid on the debt(s).
A small business can use leverage to balance a large amount of assets. This way the small business can compete with much larger competition. The fulcrum point being the debt and the distance away from the business is the fixed costs of the debt. As the fixed costs increase, the fulcrum point is moved closer and closer to the business, making it harder to maintain the weight of the increased assets.
The use of leverage depends on the needs of the company,
sometimes it is a desirable situation and sometimes in can burden the business
into failure. While using leverage it is recommended to manage
your debt very closely, use creative ways to increase sales and to put
your money or Equity into something more profitable than the cost of the
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