In financial management the term financial gearing (leverage) is used to describe the way in which owners of the firm can use the assets of the firm to gear up the assets and earnings of the firm. Employing debt allows the owner to control greater volume of assets than they could if they invested their own money only. The higher the debt equity ratio, the higher the firm equity and therefore the firm level of financial risk. Financial risk occurs due to the higher proportion of financial obligations in the firms cost structure.
The degree of financial gearing indicates how sensitive a firm’s E PS is to changes in earnings before changes in interest and taxes (EBIT).