Financial Leverage

Leverage raises return on equity whenever the business earns more on borrowed capital than the after-tax interest it pays, and it destroys equity at speed when that condition reverses. Because interest is fixed, the amplification is symmetric, so a 20% fall in operating profit produces a far larger fall in net profit for a leveraged company. It is distinct from operating leverage, which comes from fixed costs rather than from debt; the two compound. The temptation to read a high return on equity as business quality, when it is really borrowing, is exactly what DuPont analysis exists to prevent.