Pros And Cons Of Financial Leverage

Pros And Cons Of Financial Leverage

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Pros And Cons Of Financial Leverage

A company will utilize financial leveraging to increase profits by receiving a high return on a comparatively minor investment of funds. One way to accomplish this is by borrowing money to increase operating capital. With interest rates at a historic low, the cost of the interest will be small in comparison to the increased profits realized. The time is now to take advantage of these economic conditions, but a business also needs to realize the potential disadvantages they may face. Here, we take a look at both sides of the coin.

Your Credit Rating Improves

A business that effectively uses financial leveraging in this way will show that it can manage the hazards of working with debt. This bodes well for the future of the firm since its history will show that it can successfully take on a certain amount of debt when necessary. Future loans will not only be easier to obtain when needed, but the interest rates they come with will often be much more advantageous to the company. Just because a company has a good financial base, does not necessarily mean it has a good credit rating. A company, who successfully takes on and uses debt, will fix that.

Economies of Scale

This means that a company can have greater productivity when it ramps up the size of its operation. The cost per good is reduced, thus increasing the profit margin on each unit. This in turn can lead to a lower price to the customer which gives the company an advantage over the competition. In most circumstances, a firm needs to borrow the capital necessary to bring about the necessary changes to increase production.

Cash Availability

Manageable debt in a company’s financials is a plus for any business. Because debt is paid down using regular payments, it frees up cash that could have been used for operating the business. This presents a firm with more options as this money can now be used for a short-term expenditure or to take care of an emergency problem.

Increases Shareholder Equity

One use of financial leverage is to provide better earnings on the company’s stocks than may have been originally realized. A firm whose financials do not show any debt and earns 10 cents for a share of its stock will increase the equity of each share by that same 10 cents. On the other hand, if a firm earns those 10 cents per stock, it can also deduct the amount of the interest expense on its debt and add that amount to the equity each stock is worth.

Financial Risk

With debt, there is always risk. The cost of interest is never free, even when at their current low rates. These costs must be factored in when thinking about using leverage. If a company cannot repay the debt it will take on, it encounters the problem of defaulting on the loan and negatively affecting its credit score.

Bigger Losses

While a company’s profits will appear bigger with leverage, its losses will suffer the same fate. This is because the firm will have lost borrowed money. The fate of many businesses has been a disaster when careful planning and consideration were not given in plotting a new business enterprise or expansion.

Shelf Corporation

How Much Should They Cost? What Is The Industry Standard?

Aged corporations with no transaction history are priced using this general industry formula:


Cost of Filing + Cost of Maintenance + Years x ($1000)

Example: Bob finds a Nevada aged corporation that is two years old. The aged corporations cost the incorporator $750 to form and to maintain the corporation. How much is it worth?


PRICE = Cost of Corporation + Cost of Maintenance + Years Aged x ($1000)
PRICE = $750 + 2 x ($1000)
PRICE = $2750

$2,750 is the market rate for a two year old Nevada aged corporation. As an alternative, Wyoming aged corporations cost less because their formation and maintenance expenses are substantially less than in Nevada. They are just as good in terms of asset protection and financial privacy, but without the marketing hype. The same corporation formed in Wyoming may only cost $2210.