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How do you understand financial leverage?

According to Warren, leverage is the use of debt to increase a company's profits. The company borrowed 100 million USD with 7% interest and put money into business, making a profit of 12%. This means the company is earning 5% in excess of its cost of capital, resulting in a profit of $ 5m which helps to increase profits and return on equity.

The problem is that leverage is that it can help the company seem to gain a certain competitive advantage while

The reality is just using some

big debt.

Assuming the economy slipped, the company no longer made a profit of 12% but 4%, and now in the short term it appears that the loan is a goose that lays golden eggs but in the end it is not so.

Therefore, in assessing the quality and sustainability of a company's competitive advantage, Warren learned how to prevent businesses from using more debt to make a profit.

Source: Warren Buffett and the interpretation of financial Statements



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