The term leverage in a business setting refers to funds borrowed by the company to launch or expand. Working capital typically comes from business loans but not always. Perhaps you are in a position now where it is impossible to launch your start-up or expand an existing business without leveraging it.
An Example of Leverage in Action
To understand how leveraging works, imagine that you own a small snack counter inside of a mall. Business is going so well that you decide to expand to offer lunch items as well. This will require additional display cases, a larger menu board, more seating, and much more. You do not want your cash flow to go into the negative to finance the expansion, so you apply for a business loan instead. The funds from the loan allow you to grow your business, earn a greater profit, and repay the loan early.
How to Use the Debt-to-Equity Ratio to Measure Leverage
Financial service professionals use a formula called debt-equity ratio to determine whether a business has good or bad leverage. You can start the process yourself by adding up all liabilities for your company. This includes short-term debt, long-term debt, and any amount of long-term debt you must repay during this calendar year.
You will need to access your company’s balance sheet to complete the next step. Retained earnings for a corporation or owner’s percentage of equity for a limited liability company or partnership help you determine your ownership percentage. You then divide the total debt by the total equity to determine leverage for your company. A lower debt-to-equity percentage indicates better financial health. Financial service professionals typically advise business owners not to allow the debt-to-equity ratio to increase past 40 to 50 percent.
Contact Topfund Capital Today for Business Financing Options
Our finance company offers many alternative funding options for small business owners and will work with you to keep a low debt-to-equity ratio. Please contact us today to learn more.
