Gearing Ratio

Gearing Ratio

In risk analysis, any ratio that measures a company's leverage. One example of a gearing ratio is the long-term debt/capitalization ratio, which is calculated by taking the company's long-term debt and dividing it by its long-term debt added to its preferred and common stock. Another example is a simple debt-to-equity ratio, which is calculated by dividing total debt by total equity. Generally, companies with higher leverage as determined by a gearing ratio are thought to be more risky because they have more liabilities and less equity.

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Gearing Ratio

What Does Gearing Ratio Mean?

A term describing a financial ratio that compares some form of owner's equity (or capital) to borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds.

Investopedia explains Gearing Ratio

The more leverage a company has, the riskier that company may be. As with most ratios, the acceptable level of leverage is determined by comparing ratios of like companies in the same industry. The best examples of gearing ratios include the debt-to-equity ratio (total debt/total equity), times interest earned (EBIT/total interest), equity ratio (equity/assets), and debt ratio (total debt /total assets). A company with high gearing (high leverage) is more vulnerable to downturns in the business cycle because it must continue to service its debt regardless of how bad sales are. A larger proportion of equity provides a cushion and is seen as a measure of financial strength.

Related Terms:
• Business Cycle
• Debt Ratio
• Debt/Equity Ratio
• Equity
• Leverage