What are some of the best ideas today? One answer is leveraged companies.
A company may become leveraged to:
Improve business performance
For many people, a mortgage is the catalyst that makes it possible to move from renting a home to owning one. Similarly, for businesses, debt, when used judiciously, can help accelerate changes at a company, allowing it to grow more rapidly.
Improve return on equity for shareholders
Debt can have a variety of effects on a company's cash flow and earnings. On the downside, debt can diminish a company's income, and in worse cases, overwhelm a balance sheet. On the upside, however, the equity of companies that use debt successfully to grow operations can appreciate quickly, which is ultimately what matters to equity investors.
Leverage can increase return potential
- Interest payments that come with debt add to a company's operating expenses and thereby reduce profits ($50 minus $10 of interest).
- Because future income accrues to the same equity base, leveraged companies can offer attractive returns. As long as a company's cash flow can cover its interest payments, even a smaller profit margin can result in a higher return on shareholders' equity.
Return on equity is a measure of a corporation's profitability that reveals how much profit a company generates with the money shareholders have invested.
For illustrative purposes only. Individual companies may experience different effects of leverage, including negative performance results.