Leverage

Leverage A company’s long – term debt in relation to equity in its CAPITAL STRUCTURE. The larger the long – term debt, the higher the leverage. Leverage, by itself, is not a bad thing. Under conditions of BOOM, a highly leveraged company can make more profit, as the cost of interest on debt can be lower than the tax burden on the profit before tax. Since interest on debt is not taxed, the post – tax profit tends to be larger. For example, if a profit of Rs 1,00,000 has been made on loaned funds, the interest of Rs 15,000 is deducted as interest charges, calculated at 15% p.a., and tax on Rs 85,000 has to be paid. The same profit made out of the company’s own funds will be taxed to the full, and the tax payment will be higher. See LEVERAGE, INFLUECNCE OF. However, when there is a recession and margins of profits have dropped, highly leveraged companies tend to show lower net profits, and may even be in deep trouble, as money supply becomes scarce and debt – servicing costs become higher than the quantum of profit before tax.

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