What does financial leverage refer to?

Financial leverage refers to the strategy of using borrowed funds, or debt, to acquire additional assets with the aim of increasing the potential return on investment. By using debt, a company can invest more than it could with just its own capital, thereby amplifying the potential gains from those investments. When successful, this can lead to higher returns on equity, as the growth in profits can significantly exceed the cost of debt.

This approach is commonly used by businesses to finance expansions or acquisitions, allowing them to enhance their operational capacity or market presence without having to raise equity funding that might dilute ownership or control. The underlying principle is that the income generated from the investments made with borrowed funds will surpass the expense incurred in servicing that debt, whether through interest payments or principal repayments.

In contrast, the other choices involve financial strategies but do not accurately define financial leverage. The use of personal savings to invest emphasizes personal rather than corporate finance strategies. Reducing overall debt relates more to debt management than leveraging it. Lastly, selling assets for cash signifies liquidity management, not the strategic use of debt.