This article are provided for information purposes only, and are not intended as legal advice.


Leverage – is it good or bad in these economic times?

December 11th, 2009

If you want to grow quickly, the best way to grow is using leverage.  The amount of leverage that you use could be risky.  If you are extremely leveraged and things go up, you look like a genius because of the risks that you took paid off with large rewards.  However, if things went downwards, you could lose twice as much as if you would have without leverage.  The amount of risk that you take on is dependent on the amount of risk that you can tolerate and that your banker will allow you to have.

 

Interest rates are currently low therefore the cost of borrowing is relatively low at the moment.  For smaller businesses, the banks are raising interest rates, instead of giving you a loan at prime, they may now charge prime + 1.5% but in absolute percentage, your borrowing costs are still very low.  If you lock in for 5 years on a term loan, then you will be fine for the current period.  But if we look at the mortgage situation in the US, many people were taking out loans at very low interest rates, when the interest rates increased, they could not afford the loan anymore.

 

What happens if your business has too much debt?  This recession seems to have impacted specific industry segments, some companies have been affected significantly, others have prospered and others have been neutral.  If things are tight now and you have a floating interest rate, what happens if rates go up which they are predicting in one year’s time.  If business does not improve, could the banks call your loan?  You need to plan ahead and think, can my current business handle higher interest rates on existing loans?  If not, you need to cut back on expenses in order to be prepared for higher interest rates. 

 

If you are a risk taker, you will worry about this when it is too late. Maybe you believe that business will pick up and this will not be an issue.  But if business picks up, you will need more working capital to carry your receivables.  Will the banks provide you more money or will the banks over react and reduce your operating line of credit?

 

Plan for the future and borrow only what you can afford today.  If you are too leveraged now and interest rates go up, will you survive or do you need to plan ahead to make sure that you can afford the changes that will happen in the future.


Filed under: Banking — Gary Landa @ 10:39 am


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