What is financial leverage?

Financial leverage refers to the use of borrowed funds to increase the potential return on investment. This strategy involves taking on debt to acquire additional assets or invest in projects, with the expectation that the returns generated will exceed the cost of the borrowed funds. By leveraging debt, a company can amplify its return on equity, making it a powerful tool for growth and expansion when managed properly.

The effectiveness of financial leverage lies in its ability to benefit a company during periods of strong performance, as it can significantly enhance profitability. However, it also introduces a higher level of risk, as the company must ensure it can meet its debt obligations even in less favorable economic conditions. This characteristic distinguishes financial leverage from other options, which do not involve the strategic use of debt for investment.