Prudent leverage in a business can increase the return on equity. Learn how to measure a company’s degree of leverage three different ways, including debt ratio, debt to equity ratio, and asset to equity ratio.
- Sometimes shareholders, that is, owners in a company,…are not able to provide all the money necessary…to buy all the assets needed to fulfill…the company's business objectives.…In those instances, the company will need to borrow money.…Owners, or the investors, leverage their investment…in the company by borrowing money.…That leverage will make the business larger…with the same initial shareholder investment.…So why borrow?…Borrowing allows a business to have more funds available…to buy more assets, and more assets generate more sales.…
And more sales generally means more net income.…If a company can borrow money at, say, 4%,…and invest in projects that earn 10%,…who gets that extra 6%?…That accrues to shareholders.…With more leverage, that is, more borrowing,…a company's return to shareholders can be higher,…even with the same amount of shareholder investment.…So how do you measure a company's degree of leverage?…By now, you're probably familiar with…various financial statement ratios.…
Profit margin, current ratio, return on equity,…
Skill Level Beginner
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