Gearing ratio definition
The gearing ratio is a financial ratio comparing a business owner’s equity (or capital) to the company’s overall debt and borrowed funds. It’s a measurement of financial leverage, illustrating how much of a firm’s operations get funded by equity capital instead of debt financing.
Gearing ratio formula explained
Gearing ratios are advantageous when used as comparisons against other companies’ gearing ratios in the same sector and industry.
A high gearing ratio indicates a company with higher financial leverage might be more at risk of downturns in the economy, as it has larger amounts of debt than shareholders’ equity. Meanwhile, companies with lower gearing ratios have more equity to raise funds, which could put them in a better position during economic contractions.
Net gearing can be calculated by dividing the total debt by the total shareholders' equity. The ratio, which is expressed as a percentage, reflects the amount of existing equity required to pay off total outstanding debt.
- Gearing ratios greater than 50% is considered highly geared
- Gearing ratios less than 25% is considered low risk by investors and lenders
- Gearing ratios between 25% and 50% is considered normal for established companies