How Leverage Can Benefit Your Business
Using Leverage to Support Business Startup and Growth
Leverage is a business term that refers to how a business acquires new assets for startup or expansion. If a business is "leveraged," it means that the business has borrowed money to finance the purchase of assets. Businesses can also use leverage through equity, by raising money from investors.
Leverage can be a noun, as in "Leverage is a way to allow a business to expand...."
Leverage can also be a verb, as in "Businesses leverage themselves by getting loans for expansion."
The concept of leverage in business is related to the principle in physics. In physics, leverage refers to the principle that a lever can give the user a mechanical advantage in being able to move or lift objects that could otherwise not be done. In the same way, businesses can use leverage to fund company growth and development through the purchase of assets, something that could not be done without the added benefit of additional funds, through leverage.
Here's how leverage works
A small retailer wants to expand into the space next door in a strip mall. In addition to the increased rent, the business will need to buy fixtures, shelves, tables, and other retailing areas, as well as additional inventory. Most small businesses don't have cash lying around to spend, so the business will need to get a business loan. This loan is leverage, to help the business do what it couldn't do without the loan.
Leverage is a good thing, as long as the business doesn't have too much debt. If a business, like a family, has too much debt it may not be able to pay back all of its debt. When considering a business loan application, a lender typically looks at the amount of debt leverage a business has currently, to determine how much more the business can have reasonably.
Leverage as a business measurement tool
One way to look at the amount of leverage in a business is to calculate the Debt-to-Equity ratio, showing how much of the assets of the business are financed by debt and how much by equity(ownership).
Rosemary Peavler, at Business Finance, says:
In general, if the company is in debt more than 40-50%, the company needs to look at its financial statements more carefully and compare itself to other companies in the industry as it may be in financial difficulty.
In the same way as borrowing, trade credit (using vendors as creditors) can be a way to leverage your company's credit record with vendors as a financing mechanism.
Equity as Leverage
Although business debt is most often used as leverage, businesses do use equity financing as leverage. In this case, a corporation's board of directors might approve a stock offering, encouraging new investors and using their investment as leverage for business growth.