Fundamental Glossary / Debt & Financial Stability
Financial Leverage
The use of borrowed money to fund assets, so that returns and losses to equity are magnified.
Formula
A common ratio is average total assets / average equity. Debt-to-equity is the related stock measure.
What it means
Leverage works in both directions. If the return on assets exceeds the interest rate, the extra return accrues to equity and ROE rises. If it does not, ROE falls faster than the operating result.
In the DuPont split, financial leverage is the third term that turns return on assets into return on equity.
How to read it
Moderate leverage in a stable business can be a rational capital structure. High leverage in a cyclical or young business is a bet that the down year will not arrive before the debt is reduced.
What to watch
Leverage is not only bank debt. Operating leases, take-or-pay contracts, and foreign-currency debt add economic leverage that a simple assets-to-equity ratio can miss.
This note explains the term. It is not a research recommendation, a target price, or a comment on any security. Ratios and regulatory thresholds change; use the latest filing or circular for a live figure.