
Overleveraged
Meaning that if a company cannot pay back its debt, banks are able to take ownership of a company's assets to eventually liquidate them for cash and settle the outstanding debt. Taking on too much debt places a lot of strain on a company's finances because the cash outflows dedicated to handling the debt burden eat up a significant portion of the company's revenue. Financial leverage can be measured in terms of either the debt-to-equity ratio or the debt-to-total assets ratio There are many negative impacts on a company when it reaches a state of being overleveraged. An overleveraged company has difficulty in paying its interest and principal payments and is often unable to pay its operating expenses because of excessive costs due to its debt burden, which often leads to a downward financial spiral.

What Is Overleveraged?
A business is said to be overleveraged when it is carrying too much debt when compared to its operating cash flows and equity. An overleveraged company has difficulty in paying its interest and principal payments and is often unable to pay its operating expenses because of excessive costs due to its debt burden, which often leads to a downward financial spiral. This results in the company having to borrow more to stay in operation, and the problem gets worse. This spiral usually ends when a company restructures its debt or files for bankruptcy protection.





Understanding Overleveraged
Debt is helpful when managed correctly, and many companies take on debt to grow their business, purchase necessary items, upgrade their facilities, or for many other reasons. In fact, taking on debt is sometimes preferable to other means of raising capital, for example, issuing stock. Taking on debt doesn't give up pieces of ownership of the company and outside participants aren't able to direct how the debt is used. As long as a company can manage its debt burden appropriately, debt can often help a business become successful. It is only when a company stops being able to manage its debt that it causes severe problems.
Overleveraging occurs when a business has borrowed too much money and is unable to pay interest payments, principal repayments, or maintain payments for its operating expenses due to the debt burden. Companies that borrow too much and are overleveraged are at the risk of becoming bankrupt if their business does poorly or if the market enters a downturn.
Taking on too much debt places a lot of strain on a company's finances because the cash outflows dedicated to handling the debt burden eat up a significant portion of the company's revenue. A less leveraged company can be better positioned to sustain drops in revenue because they do not have the same expensive debt-related burden on their cash flow.
Financial leverage can be measured in terms of either the debt-to-equity ratio or the debt-to-total assets ratio
Disadvantages of Being Overleveraged
There are many negative impacts on a company when it reaches a state of being overleveraged. The following are some of the adverse outcomes.
Constrained Growth
Loss of Assets
If a company is so overleveraged that it ends up in bankruptcy, its contractual obligations to banks that it borrowed from, come into play. This usually entails banks having seniority on a company's assets. Meaning that if a company cannot pay back its debt, banks are able to take ownership of a company's assets to eventually liquidate them for cash and settle the outstanding debt. In this manner, a company can lose many if not all of its assets.
Limitations on Further Borrowing
Before lending money, banks conduct thorough credit checks and evaluate the capacity of a company to be able to pay back its debt in a timely fashion. If a company is already overleveraged, the likelihood of a bank lending out money is very small. Banks do not want to take on the risk of possibly losing money. And if they do take on that risk, most likely the interest rate charged will be extremely high, making borrowing less than an ideal scenario for a company already struggling with its finances.
Inability to Gain New Investors
A company that's overleveraged will find it nearly impossible to attract new investors. Investors that provide liquidity in exchange for an equity stake will find a company that is overleveraged to be a poor investment unless they receive a large equity stake with a framework in place for recovery. Giving up large equity stakes is not ideal for a company as it loses control over the decision-making process.
Related terms:
Accounting
Accounting is the process of recording, summarizing, analyzing, and reporting financial transactions of a business to oversight agencies, regulators, and the IRS. read more
Bankruptcy
Bankruptcy is a legal proceeding for people or businesses that are unable to repay their outstanding debts. read more
Cash Flow
Cash flow is the net amount of cash and cash equivalents being transferred into and out of a business. read more
Debt
Debt is an amount of money borrowed by one party from another, often for making large purchases that they could not afford under normal circumstances. read more
Debt-to-Equity (D/E) Ratio & Formula
The debt-to-equity (D/E) ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity. read more
Debt Financing
Debt financing occurs when a firm raises money for working capital or capital expenditures by selling debt instruments to individuals and institutional investors. read more
Double Leverage
Double leverage is a situation wherein a bank holding company lends money to one or more of its subsidiary banks, which in turn issues equity back to the parent. read more
Leverage : What Is Financial Leverage?
Leverage results from using borrowed capital as a source of funding when investing to expand a firm's asset base and generate returns on risk capital. read more
Operating Expense
An operating expense is an expenditure that a business incurs as a result of performing its normal business operations. read more
Senior Debt
Senior debt is borrowed money that a company must repay first if it goes out of business. read more