Quick answer
Leverage is the use of borrowed money, rather than the owners' own capital, to fund a business's assets and growth. It's usually measured by comparing debt with equity or with earnings. Moderate leverage lets a business grow faster than its own cash would allow, but it magnifies losses as well as gains, and lenders become more cautious as it rises.
Key points
- Leverage and gearing mean broadly the same thing in Australia
- Common measures: debt to equity, debt to EBITDA and loan to value
- Borrowing magnifies both returns and losses
- Higher leverage generally makes further borrowing harder and dearer
Think of a crowbar. A small push on one end moves a heavy load on the other. Financial leverage works the same way: a modest amount of the owners’ money, topped up with a larger slice of debt, lets the owners run a business or buy an asset well beyond what their own funds could reach.
How is leverage measured?
Australian lenders and accountants use a handful of ratios, each looking at debt from a different angle:
| Measure | Calculation | Why a lender looks at it |
|---|---|---|
| Debt to equity | Total debt (or liabilities) ÷ owners’ equity | How much of the business the lenders have funded compared with the owners |
| Debt to EBITDA | Total debt ÷ yearly earnings before interest, tax, depreciation and amortisation | Roughly how many years of earnings it would take to clear the debt |
| Loan to value ratio | Loan ÷ value of the security | How much cushion sits between the loan and the asset’s value |
| Debt service coverage | Earnings available ÷ yearly repayments | Whether cash flow covers the debt comfortably |
Business.gov.au defines equity as what’s left when liabilities are deducted from assets, which is the denominator most people mean when they talk about gearing.
Why does leverage cut both ways?
Here’s a simple illustration. Two businesses each buy a $500k asset that earns $75k a year before finance costs.
- Business A pays cash. Its $500k of equity earns $75k.
- Business B puts in $100k and borrows $400k. Suppose its yearly finance cost is $32k. Its $100k of equity earns $43k, a far higher return on the owners’ money.
Now trading drops and the asset earns only $25k. Business A still makes $25k. Business B still owes $32k in finance costs, so it’s $7k behind, and the owners have to find that money from somewhere. Same asset, very different outcomes. That’s leverage.
How do lenders react to high leverage?
As debt grows relative to equity and earnings, each new lender is further back in the queue and has less cushion. Expect more questions, tighter covenants, more security, or a decline from the bank. Interestingly, the Reserve Bank noted in October 2025 that most insolvent businesses carry little debt, a reminder that weak cash flow, not borrowing alone, is what usually brings a business down. Lenders know this too, which is why serviceability matters as much as the ratio itself.
Wondering how much more your business can safely borrow? Our debt service coverage ratio calculator is a good place to start, or send us your numbers.
When does leverage make sense?
Borrowing tends to work when the asset or project earns comfortably more than it costs to fund, the cash flow is reliable, and the repayment term matches the asset’s useful life. It tends to go wrong when short-term money funds long-term assets, or when one business stacks several high-cost loans on top of each other. If equity is an option, our debt vs equity comparison weighs up the alternatives.
Thinking about taking on more debt?
Used wisely, borrowing is how most Australian businesses grow. If you’d like to know what your business could realistically take on, the enquiry is a one-minute task and runs no check on your credit. We keep it in-house rather than passing it to a string of lenders, and a team member works through it and rings you. Honest figures on current debts and earnings mean the amount we discuss is realistic from the outset.
Frequently asked questions
Is leverage the same as gearing?
Broadly, yes. Gearing is the more common term in Australia and the UK, leverage in the US and in finance generally. Both describe how much of a business is funded by debt rather than equity.
What is a good level of leverage for a small business?
There's no single answer. It depends on the industry, how steady the cash flow is and what the debt funds. A business with long-term contracts and property can carry more than a hospitality venue with seasonal takings. Lenders look at whether earnings can comfortably cover repayments.
Does leasing count as leverage?
Lenders usually think so. Lease payments are fixed commitments, and larger companies reporting under AASB 16 show most leases as liabilities on the balance sheet, which raises their measured leverage.
How do I reduce leverage?
Pay down debt from profits, retain earnings rather than drawing them out, introduce new equity, or sell underused assets. Refinancing doesn't reduce leverage by itself, though it can lower the repayments.
What is operating leverage?
It's a different idea: the share of a business's costs that are fixed. High operating leverage means profits swing sharply with sales. Combined with high financial leverage, it makes a business more sensitive to a downturn.