From the course: Corporate Financial Statement Analysis
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The many debt ratios
From the course: Corporate Financial Statement Analysis
The many debt ratios
- Leverage is an important component of increasing a company's return on equity. More leverage means more assets, more assets means more sales. And more sales typically means more income with that same initial owner investment. So the benefit of leverage is that we can increase the size of our business and increase our profits by using somebody else's money. That's the benefit of leverage. But there are also risks associated with leverage. Once you borrow money, you now have the relentless fixed cost of that interest. And whether things are going well or going poorly, you still have to pay that interest. So there are benefits to leverage, there are risks to leverage. Prudent leverage in a business can increase the return on equity. But leverage has to be used carefully, it's a double-edged sword. Let's go back to the Dupont framework where we saw the benefits of business leverage. In the Dupont framework, we're looking at the three components of return on equity. Profitability…
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