What Is Leverage?

What Is Leverage?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

Leverage refers to the use of borrowed money or debt to amplify investment results. It’s like a two-edged sword; it can magnify both gains and losses. For businesses, it’s a tool used to finance operations and growth by using outside resources such as banks or creditors, rather than using their own equity. For investors, leverage comes in the form of trading on margin – borrowing money from brokers to trade financial securities. Regardless of its form, the main aim of leverage is to increase potential returns.

Related Questions

1. What is financial leverage?

Financial leverage refers to a business’s use of debt or borrowed money to finance its operations or investments, with hope that the profits generated from the leveraging activity exceed the cost of borrowing.

2. Is leverage a good thing?

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Leverage can be a beneficial tool, if used appropriately. It can help a business expand or an investor magnify their earnings. However, it can also lead to high levels of debt if not managed properly, potentially leading to financial distress or bankruptcy.

3. What does it mean to leverage a company?

To leverage a company means to utilize borrowed money or debt to finance the company’s operations or make more investments. Businesses do this with the intention that the income or gains from the leveraged activities outweigh the borrowing cost.

4. Can leverage lead to higher returns?

Yes, leverage can potentially lead to higher returns. When investments paid for with borrowed funds perform well, the returns can be much higher compared to investing with only personal funds. However, this also means risks are maximized and losses could be severe if the investment doesn’t prove successful.

5. What is a leverage ratio?

A leverage ratio is a financial metric used to assess a company’s ability to meet its financial obligations. It shows the proportion of a company’s debt in relation to its equity or total assets. A higher ratio indicates higher financial risk, but it also suggests potential for greater returns.