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Leverage refers to the use of borrowed capital to increase the potential return of an investment. In financial contexts, it commonly involves using debt to fund an investment. By using leverage, an investor can control a larger asset with a smaller amount of their own money. For example, in real estate, a buyer might put down 20% of the purchase price and borrow the remaining 80% as a mortgage. This mortgage represents leverage.

The benefit of leverage is that if the asset's value increases, the percentage return on the investor's initial capital is amplified. In the real estate example, if the property value increases by 10%, the investor's return on their 20% down payment is significantly higher than 10%. However, leverage also magnifies losses. If the asset's value decreases, the investor can lose more than their initial investment. The risk associated with leverage is therefore a crucial consideration.

In business, leverage can refer to a company's use of debt financing. A company with high financial leverage has a significant amount of debt relative to its equity. This can be beneficial during periods of growth as it allows the company to expand operations without diluting ownership. However, it also increases the company's financial risk, as it must make interest payments regardless of its profitability. Operational leverage, on the other hand, refers to the extent to which a company uses fixed costs in its operations. Higher operational leverage means that a small change in sales can lead to a larger change in operating income.