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Leverage: a strategy for generating cash flow, match rate and term coverage

Leverage: a strategy for generating cash flow, match rate and term coverage

Now, the company exists to make money too, just as individuals want to have more money to consume more or save to invest and generate extraordinary income. Here we are faced with a duality. How do we make more extraordinary income from money when we have no money? The answer is “leverage”. Sounds pretty cute, but we’ll explain the concept so we can all understand it.

Financial leverage or leverage is an indicator that shows the positive effect of using third party capital (eg a personal loan) on the profitability of your own capital (eg investing in building a house). Thanks to the leverage, we can invest more money than we already have and thus get more benefits than if we invested only the available capital (which we sometimes lack). And the more debt we have, the greater our influence. The risks are taken, but the profits can be higher as well.

Why is it suitable for financial benefit

When a company is just starting out and needs to grow profitable assets to grow its business, leverage is the most effective strategy. The key is to “match” the terms and interest rates. In other words, for example, I get $100,000 for 1 year (it’s better if I do this as a quick loan where I only pay the interest during the loan period and the capital return at maturity). A company with $100,000 applies it immediately to produce income above the cost of debt, in order to grow in assets and achieve what is called a “spread profit.” Growth with third-party capital allows a company to grow in assets much faster than if it were only growing with its own capital.

When one begins to use a leverage strategy for growth, the key is the constant renewal of debt maturities. In other words, as a company, I should endeavor not to sell its own assets so that my assets grow exponentially with constant reinvestment of profits (the famous compound interest) and in the long run repay this debt with dividends.

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In the case of a natural person, the financial leverage should generate extraordinary income and thus be able to save more money to allocate one part for consumption and another part for saving and investment. When someone incurs debts, they must ensure that that money is applied in a business for the same duration as the debt, which gives them a higher return. As soon as the work I am going to do gives me the desired profit, the first thing I do is โ€œset the profitโ€, cancel that debt and keep the extra money I made without cashing out of your pocket. Now on the contrary, if you don’t have a business to do, don’t take on debt unless it’s to cover a deficit, where the first thing is to analyze the interest rate to see if it’s in line with inflation or if it’s not appropriate to take that debt and fund yourself somewhere else.

Managing price and range gaps

The first recommendation I would make is to implement a โ€œhedge approachโ€ that relies on linking assets and corresponding financing based on their degree of stability, in a way that finances the business you want to do with the maturity of the debt taken. Second, find the interest rate I pay on the debt to be less than the return on those assets where you have applied the money obtained. The goal is to seek to manage the GAP (Gap in English) rates and terms to mitigate risks.

The most representative case is the financial intermediation carried out by the bank, although with one peculiarity. The positive rate GAP is very large, which makes it very profitable. But the negative term GAP, although huge (the banks lend in the long run but take in the short run) has a lot of liquidity and working capital that always allows them to be liquid when it comes to repaying the debt (for example, the recovery of fixed terms).

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A company that does productivity broking to fit its business, the longer it can hold current debt, the more time it will have to grow its business as long as it applies 100% of the money to the investment and generates profits.

Conclusions

When a company is just starting up, it is really very difficult to access bank financing, because the rating engines you use when financing an SME are very demanding and require at least 2 or 3 credits to be able to qualify for receiving debt (loans). , discount checks, overdraft agreements, among others).

The trust model is widely used today for young companies seeking funding. Due to the benefits that the model provides, especially taxes, this form of seed funding is highly recommended. Time means that as the company grows in assets and generates profits, it will have more possibilities to take on bank debt in order to diversify its financing strategy and replace liabilities.

In practice, it often happens that initially, companies have to pay higher financial costs in order to stabilize the market and can gradually reduce their cost of financing by accessing the Argentine financial system and capital market, where through institutional financing much better interest rates are available on longer terms much.

When we make a decision to finance ourselves, we must do so wisely, responsibly and with matching terms and prices. This is the first recommendation I can give you, just as I do by educating everyone financially on my social networks (IG:omar_de_lucca), the second is that you invest in financial education, precisely because it is something that will give you the necessary knowledge so that they can apply it on whatever work they decide to do.

Specialist in financial education and CFO of Agrosurmax.

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