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Over leveraged

  • IASbaba
  • August 26, 2022
  • 0
Economics
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In News: Bloomberg, quoting CreditSights, a unit of the credit ratings agency Fitch, reported that the Adani Group is “deeply over leveraged”, and may, “in the worst-case scenario”, spiral into a debt trap and possibly a default.

  • The report noted that the Group has been making aggressive investments that are predominantly funded with debt, putting pressure on its credit metrics and cash flow.

When is a company ‘over leveraged’?

  • A company or business is said to be “over leveraged” if it has unsustainably high debt against its operating cash flows and equity.
  • Such a company would find it difficult to make interest and principal repayments to its creditors, and may struggle to meet its operating expenses.
  • In the latter case, the company may be forced to borrow even more just to keep going, and thus enter a vicious cycle.
  • This situation can ultimately lead to the company going bankrupt.

What happens when a company is over leveraged?

  • Being over leveraged constraints companies’ growth plans.
  • If payments are not paid in time, it may lose assets, which may be taken over by creditors, who may also launch legal proceedings to recover their money.
  • The inability to repay existing debts puts limitations on future borrowing by the company.
  • Also, an over leveraged company will find it extremely difficult to get in new sets of investors, all of which will add up to further diminish its financial present and future.

Source: Indian Express

Previous Year Question

Q.1) Which one of the following situations best reflects “Indirect Transfers” often talked about in media recently with reference to India? (2022)

  1. An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment
  2. A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment
  3. An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India
  4. A foreign company transfers shares and such shares derive their substantial value from assets located in India

 

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