Leverage

A term used to describe the use of debt to improve the profitability of a business. Leverage can best be described in terms of its effect on the Balance Sheet and on the Return on Equity ratio (ROE). When a company borrows to purchase assets, it increases the asset portion of the Balance Sheet and liability portion; net worth (equity) stays the same. If the assets are used to generate more net profits, then the profitability of the business has been improved as reflected in the ROE ratio in the following example: Higher Net Profit e Unchanged Equity = Higher Return on Equity Liabilities, Current and Long-Term Liabilities are monies owed to others that are stated in summary form on a business’ Balance Sheet. They include accounts payable, taxes, sales contracts, and similar obligations.