Levarage

Lots of the current bank defaults on the international scene is blamed on these institutions being over geared. I therefore though it will be good to post a note on leverage. Leverage is the generic term used to refer to the ratio between your business' own funding and the funding it gets from external sources.

When we talk about "own" or internal funds we refer to the amount of share capital and profits that a business has. External finance consist of loans and other credit facilities (long term and short term finance).

Getting the ratio right between internal and external funding sources is important. If a business funds all its activities through internal sources it might miss out on opportunities for expansion due to the lack of investment because of the lack of internal generated profits. On the other hand if a business over depend on external sources of it runs the risk of defaulting on the loans and become insolvent.

The industry in which you operate has an influence on the level of gearing that would suite your business. If a business is asset intensive you would normally expect the business to have more finance from external sources to fund the assets, while service based business will have less external finance requirements. These are just general guidelines and leverage requirements differ from business to business.

For a more detailed look at gearing and how the ratio is calculated see the SA Business Plans or my1stBusiness websites.