When a firm has financial leverage?

When a firm has financial leverage, it means that it is using borrowed funds to finance its operations and investments, with the aim of increasing returns on equity. This strategy amplifies both potential gains and losses; if the firm performs well, the returns on equity can be significantly higher than if it relied solely on equity financing. However, financial leverage also increases risk, as the firm must meet its debt obligations regardless of its financial performance. Thus, while leveraging can enhance profitability, it can also lead to greater financial instability if not managed carefully.