Debt Capacity

Financial leverage refers to the relationship between debt and equity.  It involves the use of borrowed money to acquire assets.  A company is said to be highly leveraged if it has a limited amount of equity invested and a significant amount of debt.  High levels of debt create an opportunity for a company to increase the rate of return on capital invested to equity holders because:

• Debts must be paid,
• On time,
• With interest, and the more debt a company has
• The harder it is to borrow more,
• The more it will cost to borrow more, and
• The less able the company is to weather a downturn in business

The term deleverage or deleveraged involves a deliberate decision not to rely as heavily on debt to finance the organization's operations as well as its short-term and long-term needs.  The term also relates to companies that have taken appropriate steps to reduce the amount of outstanding debt, and in particular long-term bank or secured debt.  More precisely, deleverage means that the company's finance team looks at the status quo and then tries to create a structure that creates a better balanced balance sheet.  In contrast, increasing debt can result in additional danger relating to the survivablility of the deparment. 

The term Equity Financing refers to the process of raising money by selling shares of common stock or preferred stock.

© 2011.  Michael C. Dennis.  All Rights Reserved.