Other People’s Money

Other People’s Money (OPM)

In finance, other people’s money, or OPM, is a slang term that refers to financial leverage. Other people’s money refers to borrowed capital that is used to increase the potential returns as well as the risks of an investment. OPM can be used by individuals or by corporations.

Using other people’s money is considered a double-edged sword – it cuts both ways. If an investment that is levered with other people’s money turns out to be profitable, then the profits are magnified by the effects of the leverage. However, if the levered investment goes sour, then the investor that utilized other people’s money can incur steeper losses.

Capital structure refers to a company’s mix of debt and equity financing. Many factors must be considered when determining the optimal mix of debt and equity financing. Increasing leverage, or the use of other people’s money, up to a certain degree can benefit a company by increasing its tax shield. On the other hand, more leverage can increase the risk of default and the incurrence of bankruptcy or financial distress costs.

Other People’s Money Example

Here is an example that demonstrates the risk-return trade-off of using financial leverage, or other people’s money. Let’s say an investor has $100 and plans to invest it in a security that either gains 20% or losses 20% over the course of the year.

If the investment gains 20%, then the investor ends the year with $120, or a profit of $20. However, if the investment losses 20%, then the investor ends the year with $80, or a loss of $20. In either case, the gains and losses represent a reasonable amount in comparison to the original invested capital.

Now, let’s examine the same investment, but with the investor using other people’s money as financial leverage. Let’s say the investor borrows $400 and, along with his original $100, invests a total of $500 in the same investment. The investment will end the year either up 20% or down 20%.

If the investment gains 20%, then the investor ends the year with $600, or a profit of $100. This represents a 100% increase in the original invested capital. On the other hand, if the investment losses 20%, then the investor ends the year with $400, or a loss of $100. This represents a loss of 100% of the original invested capital.

As you can see, the use of other people’s money, or financial leverage, dramatically increased both the upside gains and the downside losses of the investment.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

Other People's Money
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

 

Other People's Money

See Also:
Angel Investor
Venture Capital
Line of Credit (Bank Line)
What are the 7 Cs of banking
Working Capital

, , , , ,

No comments yet.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.