What is leverage?

Definition of Leverage

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

Since the cost of debt is normally less than the cost of obtaining additional stockholders' equity, it is wise for a company to use some debt to control a larger amount of profitable assets. However, too much debt can mean significant risk when business conditions decline.

Leverage is also known as trading on equity.

Examples of Leverage

A company's leverage can be measured by the following financial ratios:

In these ratios, debt includes the company's current and noncurrent liabilities such as:

  • Bonds payable
  • Bank loans
  • Other loans
  • Accounts payable
  • Other amounts owed

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

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