I’ve seen a mock question ask what is the true nature of leverage when unearned revenue is increasing.
The answer says: the increase in unearned revenue will not require an outflow of cash in the future, and is thus less onerous than the company’s other liabilities, meaning that the true nature of the leverage decreased. Why is true nature of leverage decreasing?
Unlike other liabilities (accrued interest, notes payable, wages payable, etc…) that require a future cash payment obligation, unearned revenue is a liability in the sense that the company is obligated to deliver a product or service, not cash. The main difference, obviously, is what is needed to settle the liability (cash obligation vs. product/service obligation).
okay i get that explanation and how they don’t need to reduce an asset (e.g. make a cash payment). but how does that translate to the ‘true nature’ of leverage? i’m not sure what the true nature of leverage means?
It just means that your liabilities are increasing, but your leverage isn’t really (mathmateically it is, but when you think of what leverage is, unearned revenue shouldn’t be considered as affecting it since it’s not real borrowing and exposure in the same way debt is).
It’s an English idiomatic expression, not a financial definition.
thanks