What is Financial Leverage?
Nexa Consultancy | Startup & Finance Glossary
Financial Leverage refers to the use of borrowed capital (debt) to finance the purchase of assets, with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing.
For Startups: Startups typically have limited access to debt, so they rely more on equity financing. However, as they mature, they might use venture debt or other loans to fund growth without diluting founder ownership as much as an equity round would. This use of debt is financial leverage.
For Businesses: While leverage can amplify returns on equity, it also increases risk. A highly leveraged company is more vulnerable to downturns, as it must continue to service its debt regardless of its revenue performance.
Calculation: A common measure is the Debt-to-Equity Ratio.
Example: A company uses ₹10 Lakhs of its own equity and a ₹40 Lakh loan to buy a ₹50 Lakh asset. It is using leverage to control a larger asset base. If the asset appreciates, the return on the company's equity will be magnified.