Debt can be acquired either internally or externally and used to finance a company’s projects. This is leveraging. This strategy, if put against increasing equity, is often a cheaper means of sorting financing problems. When done paying for the debt, the value of a company tremendously increases and the shareholders get significant increase in their wealth. Getting into debt the right way gives a company leverage since the standing does not disturb the equity-profit relationship and as such, the company’s financial flexibility is increased. This leaves the company with sufficient room for flexibility which further allows the company to improve its products, services, processes, or portfolio which eventually gives the firm sufficient competitive advantage.
One key advantage of leveraging is the concept of tax benefits as indicated by Öztekin (2015). A company can use tax benefits to offset interest payments that accrue to a debt. When leveraging debt over equity, a company incurs debt which is accompanied by interest payments. In this sense, taxes reduce with increasing debt since a business is able to get tax breaks by reinvesting debt into their operations. Such benefits offset the cost of the debt and the business derives an advantage over those who did not seek debt and reinvested it.
Investing the debt to be leveraged on is not limited to financial planning. It can be extended even to human resource investment and this unleashes a new arsenal to use in the onslaught of competition. Investing in new machinery and processes if not accompanied by human resource development is a futile exercise. Human resource, assets, and methods should be updated simultaneously to maintain the cutting edge of the company. New knowledge and new shinny machines is a considerable investment that should shake competition to its core since, according to Malshe & Agarwal (2015), it provides the company with new means to satisfy customers.
It should be, however, noted that the level of debt should be put in check. Assuming high debt levels that are not sustainable is an undoing that seriously erodes the competitive advantage that could have been won as highlighted by Chesnick (1997). This hands over the competitive advantage to the competition and the company starts a downward spiral that can turn nasty. Debt should be entertained as long as it is capable of sustaining itself, therefore, managers should insist that debt should be about substance, not object.
Chesnick, D. S. (1997). Leveraging the future? Higher debt levels among large ag co-ops may be cause for concern. Rural cooperatives (USA).
Malshe, A., & Agarwal, M. K. (2015). From finance to marketing: the impact of financial leverage on customer satisfaction. Journal of Marketing, 79(5), 21-38.
Öztekin, Ö. (2015). Capital structure decisions around the world: which factors are reliably important? Journal of Financial and Quantitative Analysis, 50(3), 301-323.
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