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.