“Debt”, often a financial taboo for most business owners who feel that they can’t risk going into debt. There are countless books and publications made by financial experts who warn about the dangers of going into debt. It may seem prudent to completely avoid this seemingly poor financial decision for any business at all costs. In reality, there is a positive side to debt called leverage.
Financial leverage is much like a lever used by a machine to multiply the force applied to lift an object. In the case of business, financial leverage can help multiply returns, in turn generating a greater profit. As with all debt, there is increased risk involved, however there may be certain steps which can help limit uncertainty. Rather than focusing on the risks, there is a lot to be gained from putting focus on generating greater returns. A company may choose to borrow money for more assets which are believed to be beneficial in generating more revenue.
Gaining more assets such as machinery, inventory or property against money which is borrowed are common forms of how leverage may be used. Heavy machinery, large amounts of inventory or new properties are often expensive and even cost prohibitive towards small businesses that desire to make the jump and grow. While the money borrowed may present itself a greater risk, there is room to grow and make more revenue than needed to pay back the debts. This greater-risk, greater-reward method often drives many companies to seek loans from banks who are willing to bet that the market is favorable for that particular business.
Indeed, businesses that borrow may sometimes result in defaulting on the loan, but then again, not every small business is successful in the end. To say that drawing out loans is a poor choice is over-generalizing against the likelihood that a business will prove to be profitable. Contingency plans help keep a company afloat even when the market starts raining cats and dogs. Alternative sources of financing and revenue can be made available when cash flow shortages arise. Many of today’s highly-successful businesses have experienced serious financial problems at one point and still found ways to pull through. This borrowing, then proved to be a success strategy in the end once difficulties were cleared up.
For small business owners looking to grow and achieve new levels of success, financial leverage may be a strategy which they can use. With the help of our experienced accounting professionals, certain indicators can be reviewed to determine the efficacy of a new business loan as part of their growth strategy. Small business owners are welcome to reach out if they have any questions about planning for loans and financing.