Leverage

Leverage is the use of debt or other arrangements that increase economic exposure relative to the capital supplied by owners. It can amplify gains and losses. When discussing leverage, identify the level being measured: an investor’s account, a company’s balance sheet or a specific investment structure.

Debt, assets and equity

In a simple balance sheet, assets are funded by debt and equity. Different ratios describe that relationship. Debt-to-equity and debt-to-assets are not the same percentage and should not be compared as though they were.

For background on how borrowing can magnify fund outcomes, the SEC’s BDC investor bulletin discusses leveraged investment exposure. The arithmetic also helps explain borrowing in other income-producing businesses, though their rules differ.

A leverage example

Suppose a hypothetical investment owns $100 of assets funded by $60 of debt and $40 of equity. Debt-to-assets is 60%, while debt-to-equity is 1.5 times. Both describe the same simplified balance sheet.

If the assets increase to $110 and debt stays at $60, equity becomes $50. A 10% asset gain produces a 25% equity gain before financing costs and other effects. If assets instead fall to $90, equity becomes $30, a 25% equity loss.

The lender’s claim does not shrink merely because the asset value declines. That is the mechanism behind the amplification, not an additional source of guaranteed investment return.

Financing terms change the picture

Interest expense, maturities and covenants matter alongside the amount borrowed. A low-cost fixed-rate loan with distant maturity has different immediate sensitivities from short-term financing that must be renewed. Collateral requirements can also constrain flexibility.

Do not net all reported cash against debt without checking whether the cash is unrestricted and available for that purpose. Likewise, a ratio may exclude or include obligations differently from another company’s presentation. Read the definition before ranking two percentages.

Dividend analysis

Leverage helps explain changes in earning power, financing risk and capital preservation. Its role differs between a BDC lender and a property-owning REIT, but both require attention to the asset and liability sides. Treat leverage as supporting evidence, not a substitute for the company’s dividend-source earnings or the formal coverage calculation.

This article is for education and information, not individualized investment, tax, or legal advice.