Trying to understand the concept of leverage ?

<p id="isPasted">Leverage is a financial strategy that involves using borrowed money (debt) to finance assets or operations with the goal of amplifying potential returns on investment. It is a powerful tool because it allows both companies and individuals to control a larger amount of assets than their available capital alone would permit.&nbsp;</p><p>For example, an investor with ₹1 lakh could use 5x leverage offered by a broker to control a position worth ₹5 lakh. If the investment performs well, the profits are calculated on the full ₹5 lakh, magnifying the return on the initial ₹1 lakh investment.&nbsp;</p><p><strong>Key Concepts</strong></p><ul><li>Amplified Returns: When investments are successful and returns exceed the cost of borrowing (interest payments), leverage magnifies the profits for the investor or company.</li><li>Amplified Risks: The reverse is also true. If an investment performs poorly, leverage magnifies the losses, which can exceed the initial investment and potentially lead to financial distress or bankruptcy.</li><li>Fixed Obligations: The borrowed funds typically come with fixed interest payments that must be made regardless of the investment's performance or the company's profitability.</li><li>Access to Capital: Leverage provides access to significant capital for large projects, such as business expansion or real estate purchases, that might otherwise be out of reach. </li></ul><p><strong>Types of Leverage</strong></p><p>The concept of leverage extends beyond just borrowed capital and can be broadly categorized into three main types:&nbsp;</p><ul><li>Financial Leverage: This refers to the use of debt (loans, bonds) to finance assets and operations with the goal of increasing shareholder returns.</li><li>Operating Leverage: This is a measure of how a company's fixed costs (like rent or machinery) affect its operating income. A higher proportion of fixed costs means that small changes in sales volume can lead to larger changes in profit.</li><li>Combined Leverage: This metric assesses the total risk of a business by combining the effects of both financial and operating leverage on earnings per share. </li></ul><p><strong>Measuring Leverage with Ratios</strong></p><p>Analysts and investors use various ratios to measure a company's leverage and assess its financial health and risk exposure:&nbsp;</p><ul><li>Debt-to-Equity (D/E) Ratio: Compares total debt to total shareholder equity. A ratio above 1 indicates the company uses more debt than equity.</li><li>Debt-to-Assets Ratio: Shows the portion of a company's assets financed by debt. A high ratio suggests heavy reliance on borrowed funds.</li><li>Interest Coverage Ratio: Measures a company's ability to cover its interest expenses with its operating income. A higher ratio (generally above 3) is preferred.</li><li>Debt-to-EBITDA Ratio: Compares total debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), indicating how many years it would take to repay the debt. </li></ul>