Q&A - What is gearing?
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Gearing focuses on the capital structure of the business – that means the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders).
The gearing ratio, a measure of the proportion of finance provided by debt and equity, is also concerned with liquidity. However, it focuses on the long-term financial stability of a business.
Gearing (otherwise known as “leverage”) measures the proportion of assets invested in a business that are financed by long-term borrowing.
In theory, the higher the level of borrowing (gearing) the higher are the risks to a business, since the payment of interest and repayment of debts are not “optional” in the same way as dividends. However, gearing can be a financially sound part of a business’s capital structure particularly if the business has strong, predictable cash flows.
The formula for calculating gearing is:
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