Although the word 'leverage' has multiple definitions, in the financial world, it translates into borrowing money. The word 'leverage' came from the word 'lever' which refers to a device that is used to amplify the input force so as to produce a much larger output force. When it comes to a company, the addition of debt to its balance sheet paves the way for boosting its shareholders' returns, as the same quantum of profits will produce a higher ROE (return on equity) for a levered company than one with no debt.
Why a company takes debt
Corporations are (as a class) probably the second largest borrowers in the world (after countries). Broadly, companies take on debt because of two reasons when a company goes through a rough patch, it needs to borrow money to endure it and the second scenario is when a company wants to expand its operations and lacks the resources to fully finance the expansion. To appreciate the different choices that a company has, it is critical to evaluate two costs: the cost of equity and the cost of debt.
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