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What is leverage?

In accounting and finance, leverage refers to the use of a significant amount of debt and/or credit to purchase an asset, operate a company, acquire another company, etc.

Generally the cost of borrowed money is much less than the cost of obtaining additional stockholders' equity. As a result, it is usually wise for a corporation to use some debt and leverage. Perhaps this is one of the reasons that leverage is also known as trading on equity.

Financial ratios such as debt to equity and debt to total assets are indicators of a corporation's use of leverage. In these ratios debt is the total amount of all liabilities (current and noncurrent). This means that a corporation's debt includes bonds payable, loans from banks, loans from others, accounts payable, and all other amounts owed.

In a related Q&A we illustrate how leverage can increase or decrease the returns on investments.