Are You Over-Leveraged or Under-Leveraged

It’s a Simple and Important Question

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BY Ami Kassar - 21 Feb 2017

PHOTO CREDIT: Getty Images

There are a lot of important variables and tools that go into building a business: people, product, service levels, marketing messaging, culture, financing - just to name a few.

In the middle of the ever-flowing puzzle is another question that can often be the key to a lot of issues: are you over-leveraged or under-leveraged?

To put the question more simply: some companies have borrowed the maximum they can. Even if they wanted to, borrowing more money and using it to expand or grow is not an option. They have leveraged their cash flow or collateral, and there are no more alternatives.

Many companies are in the completely opposite situation: they are under-leveraged. If they wanted to inject capital onto their balance sheet, there are plenty of opportunities to do so.

If you are under-leveraged, there are a few key questions to ask.

Firstly, how much money could you borrow, at what rates, and over what terms. If you were to "maximize your leverage" or take full advantage of the cash flow or assets your company has built, how much money could you get.

And then you need to ask yourself what you would do with the money, and if the potential benefits outweigh the risks.

The goal of this exercise is not to leverage yourself to the hilt.

The intent is to start managing your business off your balance sheet instead of your income statement.

If you can borrow more money, and have a good idea what you can do with it --- come up with three simple scenarios.

What is the worst that would happen? If the investment is a disaster and doesn't generate incremental revenue - what would happen to your cash flow as you pay off the debt?

The other side of the coin is the home run scenario. If everything worked out perfectly, how much incremental profit would you generate, and how quickly could you pay down the debt?

And the third and likely scenario is something in the middle.

Sometimes working through this exercise can unlock whole new ways to think about offensively growing your business.