What is leverage in finance?

Leverage in finance refers to the use of borrowed capital to increase the potential return on investment. It allows a business or investor to use external funds, such as loans or debt, to finance operations or investments instead of relying only on their own equity. Leverage magnifies both gains and losses, meaning it can lead to higher profits if the investment performs well, but also to larger losses if it underperforms. Companies often use leverage to fund expansion, purchase assets, or increase returns for shareholders. The degree of leverage used can be measured by financial ratios such as the debt-to-equity ratio. While leverage can be a powerful financial tool, it also introduces higher risk, especially if the company’s earnings or cash flows are not sufficient to cover interest payments and debt obligations.