It’s estimated that 12-24 million ecommerce sites exist. With each day, new sites are added into the world. As with any type of business, having finances in order is key for growth and survival. Whether your financial leverage comes in a line of credit, loan, merchant cash advance or another form of funding, your ecommerce business will need it to make it.
Here, we will look at what financial leverage means in business, how it works, and your funding options for running an ecommerce business.
When it comes to business, leverage can be defined as “using borrowed capital as a funding source” to expand assets. Since you’re borrowing money, or using debt, to finance assets with potential returns, it’s an investment strategy. The hope is that the benefits will eventually outweigh the costs. So, you’ll be able to pay back the debt, plus any interest, and gain profits.
As with any type of financing, there are both upsides and downsides. The benefits of using financial leverage like a line of credit, for example, include:
If your company is considered to be “highly leveraged,” then it means that most of the capital is in the form of debt. That comes with its own sets of risks, and we will get to that shortly.
Financial leverage can be translated into a nominal amount by looking at a business’ financial statements. This will help you find out how much of the business is based in debt, or leveraged.
For starters, the main financial leverage formula to consider is:
Total Debt + Shareholder’s Equity = Financial Leverage Ratio
Shareholder’s equity can be calculated by taking the current number of outstanding shares multiplied by the current stock price. This will show you how much of your business is owed to others and not your own.
By looking at financial statements like a balance sheet, income statement or cash flow statement, you can also learn more about financial leverage with these formulas:
In these formulas, if you are running a retail ecommerce business and take out a line of credit, then that amount of credit becomes considered debt. It’s money you’re borrowing to buy assets, or equity. In this example, you may use this line of credit to purchase inventory, and inventory will translate to sales. Inventory is considered a current asset because it can be converted into cash within one year or less, if all goes well!
It’s easy to see from the above example that financial leverage is inherently taking on a risk. If you buy all that inventory on debt and cannot make sales, then you owe money and are not bringing in cash flow. That’s just one type of risk associated with financial leverage.
Financial leverage will also affect current and future cash flow. You’ll have to consider how much money you owe back on the borrowed principal amount as well as interest owed. Furthermore, your financial projections need to take into account financial leverage.
Depending on what you’re using the debt to purchase in forms of assets, there’s other risks like market risk, economic risk or the risk of natural disasters. If you use debt to purchase real estate and the values drop or a hurricane wipes out the building, then you’ve lost on your investment.
Whether you have brick-and-mortar location(s) or are solely running an online store, the explosion of ecommerce has ushered in the need for ecommerce funding. The good news is that since it’s such a popular business venture, there are many options to provide you with financial leverage.
Ecommerce businesses often rely on financial leverage because of the nature of the business. Whether you need a line of credit or quick cash to buy inventory, equipment, pay for warehousing or operational costs, etc., you will take on debt to grow.
Ecommerce is a quick-paced platform that requires you to provide value consistently to your customer. Since the internet moves so fast, you can set yourself apart by being prepared for whatever is to come. This will mean being able to get cash fast to meet spikes in demand and changing customer spending habits, so financial leverage is a concept you’ll want to know well.
Many businesses find value in taking out a merchant cash advance. But, they may need to consider using a reverse consolidation to help pay it back.