Month End Glossary

Leverage

Leverage refers to the use of borrowed funds or other financial instruments to increase the potential return of an investment or a business operation.

Leverage is a financial strategy that involves borrowing capital to increase the potential return on an investment. It is widely used by businesses, investors, and individuals to enhance their financial position by amplifying outcomes. However, while leverage can multiply profits, it also increases the risk of losses. For instance, a business may take out a loan to invest in new equipment, expecting higher revenues to offset the borrowing cost. Additionally, leverage is commonly structured through financial instruments like loans, bonds, or derivatives.

A practical example is a company that finances a majority of its operations with debt, demonstrating its high leverage. This is contrasted with a company that uses its own equity to largely finance its projects, which would be considered less leveraged. In accounting terms, a high debt-to-equity ratio often signals high leverage, which balance sheet reconcilations help monitor and manage, ensuring transparency and compliance. Leverage is a common element in month-end procedures to review a company's financial position and align its accounting practices.

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