Discussion and reply | Accounting

In the video on leverage, leverage is compared to a fulcrum in that you need just the right balance of leverage. That would seem to indicate that there is a point where the leverage is just right and that too little leverage may be just as harmful as too much leverage. Do you think this is true?

Post by classmate

My title is an attempt at the use of humor (not poking fun) in order to draw attention and enhance our learning with positivity. Moodle used to ask for titles, but Canvas does not. Seriously, that would be a great approach. I don’t think I’ve ever had a teacher take me outside as part of the learning experience and had that approach fail to enhance the experience.

When a company is leveraged it either takes on debt or barrows funds. Leverage has an increased amount of risk with an associated increase in reward. A company with less leverage has less risk and less reward. To the victor goes the spoils. If a challenger does not compete, and they take no risk, then there is no reward. Leverage can also increase profit as well as losses. There is more to lose or gain if there is more skin in the game. Risk is paired with reward. Regarding the direct comparison to gambling, in order to understand stock market wagers, because they are so similar, this is why gamblers hedge their bets. They are taking extra steps to reduce their risk. Leverage has to have an appropriate amount of balance in order to function. Too much on either side of a lever can make the lever useless. If a company is taking too many risks, and their leverage as a whole is strong, at the same time the level of risk might deter investors. Some would say Tesla takes too much risk, but Elon Musk would disagree, and he has the results to prove it. (Ross, 2021)

Loss and profit can be magnified by using the leverage of a company to take on debt, which relates to the comfort factor relating to risk. Leverage seems like a double-sided knife which is very useful but requires skill and caution in its use.

Leverage is like the potage for the three little bears, it needs to be just right. There is a happy medium for a lever, with too much on either end of the spectrum having negative consequences. The basis for that ‘just right’ factor is all based on the perspective of the bear, or the company or the individual, and how much risk they’re comfortable with based on their goals.

References

Notepirate. (2014). What is Financial Leverage or Leveraging (Cost Accounting Tutorial #18). YouTube. Retrieved from https://www.youtube.com/watch?v=uwc2I_mPrto (Links to an external site.)

Ross, S. (2021). 6 Big Risks of Investing in Tesla Stock. Investopedia. Retrieved from https://www.investopedia.com/articles/markets/102815/biggest-risks-investing-tesla-stock.asp

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