Leverage ratio: what it means, how lenders use it, and how to improve yours
Jacob Shimon is a professional finance writer at eBoost Partners with over seven years of experience in the commercial lending industry. A graduate of the University of Florida’s Warrington College of Business with a degree in Finance, he specializes in breaking down complex business lending topics to help entrepreneurs make smart, informed decisions.
The leverage ratio measures how much debt your business carries relative to its equity or total assets. Lenders use it to gauge financial risk – a high ratio means the business is heavily financed by debt, which makes it harder to take on more and increases the likelihood of default during a slow period.
Most conventional lenders want to see a debt-to-equity ratio between 1:1 and 3:1 before they’ll approve significant financing.
Leverage ratio is one of those metrics that sounds like it belongs in a corporate finance textbook but shows up in nearly every commercial loan underwrite I’ve ever been involved in.
Banks look at it. SBA lenders scrutinize it. Even alternative lenders – who claim they don’t care about financials – are quietly factoring in some version of it when they assess risk.
Knowing your leverage ratio before you walk into a lender conversation changes the dynamic entirely. You can anticipate objections, explain context, and in some cases take steps ahead of time to put yourself in a stronger position.
What is leverage ratio?
Leverage ratio is a measure of how much of your business’s financing comes from debt versus equity. It tells lenders – and you – how dependent the business is on borrowed money to operate and grow.
The core idea is simple. A business funded mostly with equity has a cushion. If revenue dips, there’s room. A business that’s loaded with debt has very little margin for error. A bad quarter can cascade into missed payments, covenant violations, and eventually default.
Two numbers come up most often in commercial lending contexts.
The debt-to-equity ratio (D/E) divides total liabilities by total shareholders’ or owners’ equity. A business with $500,000 in total debt and $250,000 in equity has a D/E of 2.0. That means for every dollar of equity, there are two dollars of debt.
The debt-to-assets ratio divides total liabilities by total assets. It tells you what percentage of the business’s assets are financed by creditors. A 0.6 ratio means 60 cents of every dollar in assets was funded by debt.
Both ratios tell a version of the same story. Lenders often look at both, and they may use different ones depending on the loan type and their internal underwriting standards.
How leverage ratio works
Start with your most recent balance sheet. You’ll need three numbers: total liabilities, total equity, and total assets.
For D/E: Total Liabilities ÷ Total Equity = Debt-to-Equity Ratio
For Debt-to-Assets: Total Liabilities ÷ Total Assets = Debt-to-Assets Ratio
Example. A manufacturing company has $1.2 million in total liabilities, $600,000 in owner’s equity, and $1.8 million in total assets.
D/E = $1,200,000 ÷ $600,000 = 2.0
Debt-to-Assets = $1,200,000 ÷ $1,800,000 = 0.67
A D/E of 2.0 means the business carries twice as much debt as equity. In manufacturing, that’s on the acceptable side of the line. For a consulting firm with minimal physical assets, that same ratio would raise serious flags.
Here’s the thing – these ratios are snapshots. They reflect your balance sheet on a specific date, which is why lenders typically look at multiple periods: year-end statements for the past two to three years, plus interim financials if your application is mid-year. A ratio that’s improving over time tells a different story than one that’s deteriorating.
Why leverage ratio matters for business lending
Lenders are fundamentally in the business of managing risk. When they look at leverage ratio, they’re asking: if this business hits a rough patch, how much runway do they have before they can’t service this debt?
High leverage compresses that runway. A business with a D/E of 4:1 is using a lot of debt relative to the equity cushion underneath it. One bad quarter, one lost client, one supply chain disruption – and the margin for error disappears.
It also matters for future borrowing capacity. High leverage means you’re already carrying a heavy debt load. Adding more on top of it is riskier for the new lender, which is why they’ll often require more collateral, charge higher rates, or cap the loan amount below what you’re asking for.
I’ve worked with clients who had excellent revenue, strong cash flow, and clean credit – but a leverage ratio that stopped conventional banks cold. They ended up qualifying through alternative channels at higher rates, then spent 18 months paying down debt and retaining profits before going back to a bank and getting the terms they should have had from the start.
Leverage ratio also interacts directly with DSCR – your debt service coverage ratio. High leverage typically means high debt payments, which compresses DSCR. When both metrics are unfavorable simultaneously, that’s a double red flag for underwriters. It’s rare to find a lender who’ll overlook both.
Key components of leverage ratio
Understanding what goes into each side of the formula helps you understand what you can actually control.
Total liabilities: This includes everything the business owes – term loans, lines of credit, equipment financing, accounts payable, deferred revenue, accrued expenses, and any other obligations. Long-term and short-term debt both count.
Owner’s equity: What’s left after liabilities are subtracted from assets. This includes paid-in capital (what owners contributed) plus retained earnings (accumulated profits left in the business over time). Retained earnings is the number you have the most direct control over – which is why distributing too much profit in a given year can hurt your leverage ratio heading into a loan application.
Total assets: Everything the business owns – equipment, real estate, cash, receivables, inventory, and intangibles (in some cases). Asset composition matters. A business with $2 million in assets mostly made up of receivables looks different to a lender than one with $2 million in physical equipment or real estate.
The quality of assets matters as much as the quantity. A lender may apply haircuts – reductions to stated asset values – when calculating ratios, especially for receivables, inventory, or intangibles that are harder to liquidate.
Leverage ratio thresholds and benchmarks
There’s no universal number that works for every lender and every industry. Context is everything. But here are the ranges I see in practice.
SBA loans (7a and 504): SBA guidance generally looks for a D/E ratio under 3:1 for most businesses. The exact threshold varies by program and lender, but 3:1 is a practical ceiling for most applications. Above that, you’ll face additional scrutiny, injections may be required, or you may not qualify at all.
Conventional bank lending: Banks typically want to see D/E between 1:1 and 2:1. Some will go to 2.5:1 for well-established businesses with strong cash flow and clean payment history. Much beyond that and most bank credit committees will pass.
Alternative and online lenders: These lenders weight cash flow far more heavily than leverage ratios. They’ll often lend to businesses with D/E ratios of 4:1 or higher, as long as monthly revenue and debt service coverage hold up. The tradeoff is higher rates and shorter terms.
Industry benchmarks: Manufacturing businesses commonly operate at 2:1 to 3:1 – capital-intensive businesses typically carry more debt. Professional service firms (law, accounting, consulting) tend to run 1:1 or lower because they have few physical assets and lower capital requirements. Retail can run higher, sometimes 3:1 or beyond, because inventory financing is common. Real estate investment companies often have leverage ratios that look alarming in isolation – but lenders evaluate those against asset value and cash flow rather than against a simple ratio benchmark.
Common leverage ratio mistakes
Taking large owner distributions right before applying for a loan is one of the most common – and costly – mistakes. Distributions reduce equity. Lower equity means higher leverage ratio. This is something I catch with clients regularly during our pre-application review.
Carrying unnecessary short-term debt is another one. Lines of credit drawn down to the limit, vendor payment terms stretched beyond what’s needed – all of that shows up as liabilities on the balance sheet and pushes your ratio higher. Pay down what you can before your balance sheet date if a loan application is coming up.
Not understanding that both sides of the ratio matter trips people up. Some business owners focus on paying down debt without realizing they could also be building equity through retained earnings. Both moves improve the ratio – retained earnings is often the faster lever.
Comparing to the wrong benchmark is a mistake that goes both ways. Some business owners panic when they see a D/E of 2.5:1 and assume they’re in bad shape – but in manufacturing, that’s fine. Others see a 1.5:1 and feel comfortable, not realizing that for their specific lender and loan type, 1:1 is the actual threshold.
How to improve your leverage ratio position
Pay down debt systematically. Start with shorter-term, higher-interest debt that isn’t tied to productive assets. Eliminating a line of credit balance, for example, directly reduces your liabilities without losing any assets.
Retain more profit. Every dollar you leave in the business rather than distributing increases retained earnings, which increases equity, which improves your D/E ratio. This requires some planning around taxes, but it’s the most straightforward long-term path.
Bring in equity capital. An investor, a partner buy-in, or an equity injection from an SBA loan program (the SBA 504 program requires a borrower equity injection of at least 10%) all increase the equity side of the equation. This is worth considering if you’re planning a significant expansion and want to do it without maxing out your debt capacity.
Refinance short-term debt to long-term. This doesn’t improve the ratio directly – the liability is still there – but it can improve cash flow (lower monthly payments), which improves DSCR, which is often evaluated alongside leverage. A working capital loan restructured as a longer-term facility can have this effect.
Honestly, the best time to think about this is before you need financing. Twelve to eighteen months of deliberate equity building and debt reduction can move your ratio from borderline to clearly bankable.
Tools and resources
Your accountant or bookkeeper should be able to pull a balance sheet on demand. If you’re using accounting software like QuickBooks or Xero, you can generate one yourself in under a minute. Run it, look at the three key numbers – total liabilities, equity, total assets – and calculate both ratios before you approach any lender.
The SBA’s financial standards documentation (available on sba.gov) outlines the general financial thresholds used in their loan programs. It’s not light reading, but it gives you a sense of where the formal benchmarks sit.
The business line of credit guide from eBoost Partners covers how revolving credit factors into your overall debt picture – relevant if you’re trying to understand what’s showing up in your liabilities.
The eBoost Partners business credit guide covers related metrics including UCC-1 filings and balloon loan structures that interact with leverage in commercial lending scenarios.
Financing options to consider
If your leverage ratio is in a good range – D/E under 2.5:1 – you’re likely in a strong position for SBA loans, conventional bank term loans, or a business line of credit. These will offer the best rates and terms. Apply to multiple lenders or work with a broker who can match you based on your actual profile.
If your ratio is high – D/E above 3:1 – alternative lenders are usually the more realistic path in the short term. They’ll want to see strong monthly revenue, consistent cash flow, and a reasonable DSCR. Rates will be higher, terms shorter. Use that financing strategically while you work on the balance sheet.
Equipment financing is worth considering separately. Lenders evaluating equipment loans often look more at the collateral value of the equipment and your cash flow than at your overall leverage ratio. It can be a way to acquire assets without worsening your overall financial picture as much as you’d expect. Equipment financing through eBoost Partners works for a wide range of industries and credit profiles.
At eBoost Partners, we look at the full financial picture before recommending a path. If you’re not sure where your leverage ratio puts you, start an application and we’ll work through it with you.
Disclaimer: The information in this article is for educational and informational purposes only and does not constitute financial advice. All funding products, rates, and terms are provided by eBoost Partners and are subject to application, credit approval, and our current underwriting criteria. Rates and terms are subject to change without notice.
Frequently asked questions
What leverage ratio do banks want to see?
Most conventional banks prefer a debt-to-equity ratio between 1:1 and 2:1 for standard business term loans. Some will extend to 2.5:1 for businesses with strong cash flow, a long operating history, and solid collateral. SBA lenders generally allow up to 3:1, though the specific program and lender can affect that ceiling.
Alternative lenders are significantly more flexible, often approving businesses with D/E ratios above 4:1 if the cash flow picture is strong enough. Keep in mind that these numbers are guidelines – individual underwriters look at the full picture, and industry context affects what’s considered acceptable.
Is a high leverage ratio always bad?
Not always. Leverage is a tool. Using debt to fund productive assets – equipment that generates revenue, real estate that appreciates, inventory that turns – is how most businesses grow. A high leverage ratio is concerning when the debt isn’t tied to productive assets, when cash flow is too tight to comfortably service it, or when there’s no clear path to reducing it.
Context matters a great deal. A 3:1 ratio in a capital-intensive business with predictable cash flows looks very different than the same ratio in a service business with no physical assets and volatile revenue.
What I tell my clients is this: high leverage becomes a problem when it limits your options. If it’s keeping you out of the financing you need, it needs to be addressed.
How does leverage ratio affect my loan interest rate?
Higher leverage typically means higher rates, for two reasons. First, lenders view heavily leveraged businesses as riskier borrowers – there’s less equity cushion between current debt levels and insolvency.
Second, a business with high existing debt often has less collateral available to pledge, which reduces the lender’s security. Both factors push rates up. The effect is most pronounced in conventional bank lending, where pricing is often tied explicitly to financial ratios.
SBA loans have more standardized rate structures (prime plus a spread), so leverage ratio affects your ability to qualify more than it affects the rate itself. With alternative lenders, the rate is often primarily driven by revenue and cash flow metrics, but high leverage is still factored into risk assessment.