Leverage is created through various situations:

  • A company takes on debt to purchase specific assets. This is referred to as “asset-backed lending” and is very common in real estate and purchases of fixed assets like property, plant, and equipment (PP&E).
  • A company borrows money based on the overall creditworthiness of the business. This is usually a type of “cash flow loan” and is generally only available to larger companies.
  • When a company borrows money to finance an acquisition (learn more about the mergers and acquisitions process).
  • When a private equity firm (or other company) does a leveraged buyout (LBO).
  • When an individual deals with options, futures, margins, or other financial instruments.
  • When a person purchases a house and decides to borrow funds from a financial institution to cover a portion of the price. If the property is resold at a higher value, a gain is realized.
  • Equity investors decide to borrow money to leverage their investment portfolio.
  • A business increases its fixed costs to leverage its operations. Fixed costs do not change the capital structure of the business, but they do increase operating leverage which will disproportionately increase/decrease profits relative to revenues.