Definition
The financial term leverage refers to the use of debt to increase the total profits returned to the company's equity holders.
Explanation
When companies borrow money from creditors, they can use those funds to make investments in projects that will return additional profits to the owners of the company (common shareholders). As long as these new projects provide an adequate return on investment, shareholder wealth will increase.
Extensive or overuse of leverage can pose a serious risk to these same common stockholders. If these projects did not provide an adequate return on investment, the company may not be able to meet the interest and principal payments on their loans. Creditors may force the company into bankruptcy, which could result in liquidation, or reorganization.
Leverage ratios are financial measures used to quantify the relative amount of debt used by companies.
Related Terms
- The term return on investment, or ROI, is used to describe a number of financial metrics that are used to measure the profitability of a company. All of the return on investment metrics use variables found on both the income statement and balance sheet.
Moneyzine EditorNovember 6th, 2024 
Generally, companies have two options when they wish to raise money. They can issue shares of stock, which are also known as equities. Alternatively, they can issue bonds, which are also known as debt instruments. Leverage ratios tell investors how much debt a company has outstanding relative to the equity in their capital structure.Moneyzine EditorNovember 6th, 2024- The term bankruptcy is used to describe the legal status of an individual or company that cannot repay money owed to creditors. Debtors file for bankruptcy status, which is then ordered by a court of law.Moneyzine EditorSeptember 25th, 2023
