What is Leverage?
The term "leverage" is used in this context most often in business and investing circles. For instance, businesses can leverage debt, but they can also leverage their assets, social presence, fanbase, or political connections.
Leverage Works with this!
The business borrows money with the promise to pa
y it back, just like a credit card or personal loan. In many ways, this leverage works like any other form of debt. Investors usually prefer the business to use debt financing, but only to a certain point. Investors get nervous about too much debt financing, as it drives up the company's default risk.
3 Types of Leverage
1. Financial Leverage
Financial leverage follows the straightforward definition of leverage discussed so far. The use of financial leverage in bankrolling a firm's operations can improve shareholders returns without diluting the firm's ownership through equity financing.
2. Operating Leverage
Operating leverage applies the concept of leverage to the cost of providing goods and services. If a business firm has more fixed costs as compared to variable costs, then the firm is said to have high operating leverage.
3. Combined Leverage
This combines operating leverage, which measures fixed costs and assets, with the debt financing measured by financial leverage. It's the total amount of leverage that shareholders can use to borrow on behalf of the company.