Monday, March 11, 2013 11:53 AM
View other posts by John Mitchell
Leverage is illusive. We use it to magnify the returns and the results of our labor. But leverage increases variability. The same force that causes homeowners to see giant returns when the house they bought with a 20% down payment increases in value quickly erases equity when home prices fall, as during the 2008 financial crisis. The leverage that makes fortunes in the derivatives markets also potentially causes catastrophic losses, as in the case of Barings Bank and AIG. You may wonder if leverage can ever be used safely.
One way to look at leverage is as the use of assets or liabilities that generate fixed costs to improve the relationship between revenue and variable cost. Therefore, you need to understand this risk-return relationship created by leverage. Without this understanding, the lure of higher returns may cause you to use operating and financial strategies that incorporate an unsafe amount of leverage.
Should you buy a machine that replaces labor by automating your production process? Should you borrow the money to buy the machine instead of financing with equity? Both of these decisions revolve around leverage. By understanding this, you can make decisions about the best combination of debt and equity, about whether it is worth incurring fixed operating costs to reduce variable costs, and whether the use of fixed operating costs makes it unwise to incur fixed financing cost.
In this course, you will identify common leverage ratios and how they relate to each other, examine the risk-return effects of leverage, and how managers, owners, and creditors use leverage to ensure it works to their advantage.
Are you able to use leverage to make profitable decisions while avoiding risk? Analyzing Leverage Ratios for Effective Decision Making will help you develop the skills you need to enhance corporate profitability, control risk, and manage with confidence.