Saturday, November 26, 2011

Leverage 2.0 - How will you leverage ?

How will you use the power of leverage ?

LEVERAGE 1.0 : I have $1 and I know how to earn $2 from it.  But earning $2 is not interesting to me.  So I found a way to borrow $30 to do it.

My debt ratio is 30:1

Supposedly after it is done, I earn $60, pay back the $30 and $5 interests/fees.  I could have earned $25 instead of $2.  This is the power of leverage, amplify my earnings.

But when things go south, I haven't earned the $60 yet but I have already owed someone $35.  I just needed more time and I CAN get more time by just paying more interest/fee.  This time its another $8.  So I will need to pay back $43 but if I could earn the $60, I still have a profit of $17.  Not as good as $25 but still better than $2.

Just in case my $60 still hasn't come in yet, I could extend my time again by paying another $10 interest/fee.  By then my potential profit is $7, much worse than $25 or $17, but still better than $2.

However eventually the interests add up so much that I don't get any profit even if I get my $60.  So it is NOT exciting again.
time            loan    interest  potential earning
1st round : $30 +    $5         $25
2nd round : $35 +   $8         $17
3rd round : $43 +  $10          $7
4th round : $53 +  $15         -$8
5th round : $68
What happened above is considered a 'traditional' scenario.  I thought I could earn $2 from $1 but I was wrong.   I use leverage to amplify my earnings, however after 5 rounds of trying I still fail and I ended up amplifying my lost!  So I have to pay $68 tuition fee to learn a lesson, both on my business skill and also on the power of double edge leverage.

LEVERAGE 2.0 : What could also happen is that when I first get my $30.  I put $15 aside.  So it would look as if I have $15 and I have borrow $30, although my $15 is actually from the $30.  So my debt ratio is only $30 : $15 or 2:1.

When I realize I couldn't get my earning in the first round, I could borrow another $60 because my debt ratio is low.  Then I pay the earlier loan and interest ( $60 - $35 ) so I still have an extra of $25 to do more business.

I can continue borrow more and more to cover my previous loan and yet I have more money to do more businesses.

time            loan   ratio  interest  buyStock  potential earning
1st round  :  $30   2:1    $5          $15              $10
2nd round :  $60   4:1    $9          $25              $26
3rd round :  $120  8:1   $17         $51              $60
4th round :  $240 16:1  $33          $103           $130

As soon as I hit my debt ratio limit, I can set aside some money as if it is my capital/earning like how I did the first time.  Says I add another $15 to make my capital to $30.  Borrowing $240 is only a debt ratio of 8:1.  This can continue indefinitely.

With this method,

  • it appears as if I pay off my loan on time, every time. = good paymaster
  • I gets lower interest because of my good records and higher loan amount
  • I always have some extra money even before my real earning comes in = strong cash flow
  • my potential earning actually increase every time as I keep turning = good strategy
  • as long as I eventually realize one earning , I offset ALL my previous risks and I still make a REAL profit.

Don't get me wrong.  Although many people did the above illegally with the wrong methods.  But there are actually perfectly legal and legitimate ways.  As a matter of fact, almost ALL big businesses or even governments are doing exactly above.

As you may have observed, the risk is much higher now.  By the 4th round, I owe $273 instead of just $68 comparing to the earlier traditional method.  But with all the great benefits mentioned above (better strategy, stronger cash flow etc), this increased risk could still be justifiable.

Things still haven't really gone wrong yet with above creative strategy assuming it was done legally.

Things go wrong when

  • I didn't really know how to earn $2 from $1 = it was a bluff and people found out
  • I didn't really try hard at all to realize any earning 
  • I didn't use the extra cash flow to grow the business
  • I use the extra cash flow for new house, cars etc. = corruption
So the 'finance system' has opened a whole new world to us but at the end it is 'ourselves' who collapse it.  Don't blame the system, blame the greed and ignorance within ourselves who are playing with the power of leverage for the wrong reasons.

How will you use the power of leverage ?


Kris said...

This is a case of rolling the cashflow.

That is why people always say that businessmen will have a hard time coughing out hard cold cash even though they may "look" rich.

Michael Tsen said...

cash is king :)

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