Say we have two businesses, one is **software** and another one is **heavy machinery.** Let us create scenarios. We know that the software industry needs **fewer** **value assets**(computers) to create **revenue **but the heavy machinery industry needs **higher** **value** **assets**(imported machines, earthmovers etc) to create **revenue**. This is called '**Return on Assets(ROA).**

So **ROA **for **Software** is much higher than **Heavy machinery.** For example, to get **1 rupee** from **assets annually**, I need **2 rupees of assets** in **Software** and **10 rupees of assets** in the **Heavy industry.**

ROA = Output/Input

ROA for software is Rs.1/Rs.2 = 50% annually

ROA for heavy machinery is Rs.1/Rs.10 = 10% annually

Clearly, the software industry is the winner here. But let us do permutations and combinations here.

**Scenario-1:**

I put money 1 lakh in software.

Here the return annually = 50% of 1 lakh = **Rs.50000**

I put money 1 lakh in heavy machinery.

Here the return annually = 10% of 1 lakh = **Rs.10000**

**Clearly, the software business is the winner.**

**Scenario-2:**

You can invest 1 lakh at the maximum. So if you need to invest more, you are likely to raise a loan.

More asset value = More loan because loans can be recovered by selling the assets.

Which one has more asset value? Clearly **Heavy machinery.** Also, we don't need more investments in **Software **as Rs.1 lakh is more than sufficient.

But say we got a loan of Rs.9 lakhs at 5% interest annually. So the investment amount is Rs.9 lakhs(Loan) + Rs.1 lakh(own).

ROA for this will be 10% of 10 lakhs = **Rs.1 lakh**

This 1 lakh is without deducting interest for the loan. So the **interest** amount is would be 5% of 9 lakhs = **Rs.45000**

Net **earnings** is Rs.1 lakh - Rs.45500 = **Rs.55000.**

Now we got **Rs.55000**.We know that **Return ratio = output/input.**

Here is the interesting part our overall asset value is 10 lakhs but the contribution from our own money is just Rs.1 lakh

Return on 'X' = Rs.55000/Rs.1 lakh = **55%.**I am sure this scenario would surprise you because with the same amount of investment in the same business I get more return by just raising a loan. This return is called **'Return on **Equity**(ROE).** **Equity means only the owner contribution to assets.**

This whole concept of using the loan or other source of funds for increasing the return is called 'Leveraging'

Almost all capital heavy industries or businesses use this leverage. Some examples are automobile, telecom, oil&gas, mining etc.

Note: Leveraging is two-edged sword and it also depends onthecost of borrowing(interest rate).That's why countries with lesser interest rates have more capital heavy industries. India has abnormally high-interest rates and hence fewer industries and manufacturing compared to its peers.