Gearing Ratio

DEFINITION of 'Gearing Ratio'

A general 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.

Also known as the Net Gearing Ratio.

BREAKING DOWN 'Gearing Ratio'

The higher a company's degree of leverage, the more the company is considered risky. As for most ratios, an acceptable level is determined by its comparison to ratios of companies in the same industry. The best known 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 the company must continue to service its debt regardless of how bad sales are. A greater proportion of equity provides a cushion and is seen as a measure of financial strength.

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RELATED FAQS
  1. What is a good gearing ratio?

    A company's profit and loss statement, or balance sheet, gives a lot of insight into its degree of financial stability. For ... Read Full Answer >>
  2. What does the gearing ratio say about risk?

    Technically speaking, there are many different gearing ratios, the most popular of which is the debt to equity ratio. Gearing ... Read Full Answer >>
  3. What is considered to be a bad gearing ratio?

    Metrics that assess a company's financial stability or ability to meet debt obligations play an important role in many sectors ... Read Full Answer >>
  4. What is the difference between the gearing ratio and the debt-to-equity ratio?

    Gearing ratios form a broad category of financial ratios of which the debt to equity ratio is the predominant example. Accountants, ... Read Full Answer >>
  5. Can mutual funds use leverage?

    Traditionally, mutual funds have not been considered leveraged financial products. However, a number of new products have ... Read Full Answer >>
  6. How do hedge funds use leverage?

    Hedge funds use several forms of leverage to chase large returns. They purchase securities on margin, meaning they leverage ... Read Full Answer >>
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