IT Managers Need To Know About Financial Leverage

by drjim on September 27, 2012

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To get things done, a company has to have leverage…

To get things done, a company has to have leverage…

As an IT manager you are going to want to be able to show some leadership and be able to have intelligent conversations with the people who are running your company. More often than not, those people are either going to be working in the company’s finance department or they are going to have a finance background. This all means that your management is going to be using big words like “leverage” that you’re going to have to understand. Let’s do something about that right now.

What Is “Leverage”?

If you’ve watched any movie in the past few years that dealt with a business or money, then undoubtedly you’ve heard the actors use the phrase “…he’s highly leveraged…” This leads to the question: what are they talking about? In the world of business, financial leverage refers to the act of borrowing money so that you can acquire an asset. When somebody (or some company) is highly leveraged, then they’ve acquired an asset using more of someone else’s money than their own.

You don’t want to get this kind of leverage confused with another type: operating leverage. Operating leverage is talking about the extent to which a company’s operating costs are fixed versus variable.

How Do Companies Use Leverage?

Borrowing money is a bad idea, right? Isn’t this what all of our parents told us as we were growing up? Well, it turns out that when used correctly, leverage is a very powerful business tool that can help your IT dream team do more projects.

Let’s say that your company wanted to implement an IT program that was going to cost $1,000,000. Your company contributes $200,000 and borrows $800,000 to fund the project. A year goes by after the project has been implemented and your company has generated an extra $2,000,000 in profits because of the project. Ignore the cost of borrowing the money and assume that the company repays the borrowed $800,000. This leaves the company with $1,800,000 in profits after they repay themselves for funding the project. Clearly using leverage really paid off in this situation.

What Does All Of This Mean For You?

Financial leverage is a technique that companies use in order to implement projects that they don’t currently have enough funding to do by themselves. This is a powerful technique that comes with some risks.

Firms borrow money, leverage, and combine it with their own money to fund activities that they want to perform. Assuming that the value of the activity increases, then the firm can repay the borrowed funds and will emerge with more funds than they had when they began. If the activity decreases in value, then the firm will end up losing money.

Using leverage can allow a firm to perform more IT projects and to start them sooner than if they didn’t. However, the use of leverage puts the entire firm at risk of not being able to repay its loans. IT managers need to understand how this powerful financing technique works and what they need to keep an eye on when it’s being used.

– Dr. Jim Anderson
Blue Elephant Consulting –
Your Source For Real World IT Management Skills™

Question For You: Do you think that it’s a good idea to fund IT projects using borrowed money?

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What We’ll Be Talking About Next Time

So IT manager, how is your company doing? Are they going to be able to fund your IT dream team’s projects this year? Will there be any money left over for your management to hand out as bonuses to your IT team in order to make sure that they stay on board and don’t bail? The best way to find out how your company is doing is to show some leadership and take a look at its income statement. Let’s make sure that you know how to read it.

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