Leverage in simple terms means debt. In this case, leverage is the borrowed capital that is used to amplify return on investment. In this article, let’s try to analyse how leverage can be used by businesses to amplify their returns:
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Leverage is an investment strategy used by businesses to purchase or acquire an asset using borrowed money. This is done with the motive to increase the return on investment. In simple terms, leverage is the amount of debt used by a company to finance the purchase of assets.
While purchasing a property, business owners can either use debt or equity to finance the cost of acquisition of assets. Using debt can be beneficial and also be risky. While debt helps the company to increase its profits and returns, it might also pose the threat of the company’s bankruptcy. Debt financing is a preferred option, as it lowers the risk of dilution of the owner’s equity which is usually an effect of excessive issuing of more shares of stocks.
Another significant benefit of debt financing comes in the form of tax deduction. With debt financing you are likely to get tax benefits on your loan, as the interest payment on your loan can be claimed for a tax deduction. In addition to that, the timely repayments of the loan will enable you to build a positive repayments history and improve the credit ratings of your business.
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There are several strategies using which you can leverage your wealth in business. Listed below are ways to leverage your personal wealth for funding your business:
If you have an existing business and have a good credit score then you may opt to secure a business line of credit for funding your business. For existing businesses, banks and other financial institutions will provide you with business loans. However, the funds you can secure depend on your credit score. For a start-up business, you can try to secure start-up loans that offer subsidies. The debt used to finance your business will be profitable only if you make an additional profit over and above the interest payments on your loan.
Instead of simply investing the money from your personal account, you can loan the money to your business. You may use this strategy if you have some additional savings. Thus you can get the money back along with some interest. It is important to maintain the records of how much money you have invested throughout the process in order to earn it back.
Similar to investing money in the stock market, individuals can also invest money in their own business. This is different from advancing money to your own business. In this process, you invest your money in the business and you can earn more money in return if your business thrives. This strategy is helpful when you hold a business in partnership. Here you must be careful about the money you take out as the owner’s draw.
Use the venture capitalist funding to invest in your business. Venture capitalist funding is a technique through which businesses raise funds from investors who are willing to exchange equity in return for money. This helps businesses acquire funds necessary for its growth and expansion. However, such investors also look for greater control of the company and a quick return on the investments.
Angel funds can be used when your business is in its nascent stage. You may secure funds from wealthy investors by providing him with an innovative business model. Angel investors are usually affluent investors who provide capital for a business to start in exchange for equity ownership or convertible debts.
Leverage is the process of borrowing funds or securing a line of credit to expand or fund business expenses with the goal to amplify the returns into a greater value so as to profit the investors and the business. However, debt financing should be used up to a certain limit. Too much of debt financing may expose a company to default risk.
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While debt can be a risky tool, it is equally important to accumulate wealth if used in the right way. Thus businesses must use a balance while using leverage. While it is used to the advantage of the business, over-leveraging may lead to the downfall of the business during an economic slowdown.
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