Concept of leverage

Leverage is a financial strategy where a company uses fixed costs to potentially amplify returns for its shareholders. These fixed costs can stem from operations (like rent) or financing (like debt interest).

The basic concept:

• Leverage: Using assets or funding sources that have fixed costs/returns.
• Goal: To increase returns to shareholders.
• The Catch: Leverage also increases risk.

Whether leverage is successful (favorable) or detrimental (unfavorable) depends on how well the company's earnings cover those fixed costs. If earnings are high, leverage works well. If not, losses can be magnified.

There are different types of leverage (operating and financial), but the main idea is the same: using fixed costs to potentially increase profits, while understanding and managing the associated risk.