Leverage - Definition & Advantages of Leverage | What is Leverage?

Leverage Definition

Leverage is using borrowed money to increase the potential return on investment. It assists businesses and investors in amplifying their profits. 

Overview

Through leverage, borrowed money is used to invest or buy income-generating assets. The returns are then used to pay off the debt, increasing profit margins. 

Uses of Leverage

Leverage boosts investors' market power, helping them to invest more and increase potential profit. Businesses can also use debt to increase shareholder value instead of issuing new shares. 

Characteristics

1. Leverage uses debt to amplify investment profits.

2. Investors can increase their market power through leverage.

3. Businesses use leverage to finance assets and enhance shareholder value.

4. Debt-to-assets and debt-to-equity are common financial leverage ratios.

5. Leverage misuse can lead to severe financial crises.

Advantages of Leverage

1. Leverage can increase profits for traders and investors.

2. It allows for more substantial investments with less initial capital.

3. Leverage is useful for short-term financing needs during acquisitions.

4. Innovative businesses can use leverage to seize opportunities.

Types of Leverages

1. Operating Leverage: Using leverage for investing operations.

2. Financial Leverage: Determined by the debt to equity ratio.

3. Combined Leverage: The combination of operating and financial leverage.

4. Working Capital Leverage: Impacts a business's profitability and risk.