What is leverage?
Leverage works through a combination of borrowing and investing, where borrowing refers to obtaining funds from outside sources like a bank, while investments refer to using own funds for purchasing assets such as stocks, bonds, and property.
Types of Leverage
There are three main types of leverage: financial, operating, and combined. Financial leverage involves the use of financial sources like debt or equity to acquire additional capital to fund projects or investments. Operating leverage refers to the use of fixed operating costs in comparison with variable cost, allowing for a larger profit potential with increased sales volume. Lastly, combined leverage combines financial and operating levers and creates a synergistic effect to increase total profits. When used prudently, each of these forms of leverage can have a powerful impact on increasing profits and generating financial success.
Why is leverage important?
Leverage is an important concept to understand in business and financial contexts. It involves using borrowed capital in order to amplify potential returns from investments. Leverage can be especially useful when attempting to maximize profits while mitigating risk; with the right combination of debt and equity, businesses can often outpace what they are able to accomplish with their own resources alone.