Loading the player...

What is 'Gearing'

Gearing refers to the level of a company’s debt related to its equity capital, usually expressed in percentage form. It is a measure of a company’s financial leverage and shows the extent to which its operations are funded by lenders versus shareholders. The term "gearing" also refers to the ratio between a company’s stock price and the price of its warrants.

BREAKING DOWN 'Gearing'

Gearing can be measured by a number of ratios, including the debt-to-equity ratio, equity ratio and debt-service ratio. The ratios serve as indicators regarding the level of risk associated with a particular business. The appropriate level of gearing for a company depends on its sector, as well as the degree of leverage employed by its corporate peers. For example, a gearing ratio of 70% shows that a company’s debt levels are 70% of its equity. A gearing ratio of 70% may be very manageable for a utility, as the business functions as a monopoly with support through local government channels, but it may be excessive for a technology company with high levels of competition in a rapidly changing marketplace.

Use of Gearing Ratios

Lenders may consider a business’s gearing ratio when determining whether to extend credit. This information can be combined with whether or not the loan will be supported with collateral, as well as if the lender will qualify as a senior lender should the business fail. With this in mind, senior lenders may choose to remove short-term debt obligations when calculating the gearing ratio, as senior lenders receive priority in case of the business’s bankruptcy.

In cases in which a lender would be offering an unsecured loan, the gearing ratio may include information regarding the presence of senior lenders as well as preferred stockholders that have certain payment guarantees. This allows the lender to adjust the calculation to reflect the higher level of risk than would be present with a senior lender.

Gearing Ratio and Risk

In general, a company with excessive leverage, as demonstrated by its high gearing ratio, may be more vulnerable to economic downturns. That's because it must make interest payments and service its debt through cash flows that may decline during the downturn. The flip side of this argument is that leverage works well during good times, since all the excess cash flows accrue to shareholders once the debt service payments have been made.

In contrast, lower leverage does not guarantee sound financial management on the part of the business. Certain industries that are highly cyclical in nature, such as those with significant seasonal variances, may not have the funds available year-round to meet debt obligations over a specific amount. This could include businesses in certain agricultural sectors as well as those tied to fluctuating seasonal demands, such as garden centers.

RELATED TERMS
  1. Double Gearing

    Double gearing is the practice of two separate entities using ...
  2. Leverage Ratio

    A leverage ratio is any one of several financial measurements ...
  3. Capitalization Ratios

    Capitalization ratios are indicators that measure the proportion ...
  4. Debt Ratio

    The debt ratio is a financial ratio that measures the extent ...
  5. Long-Term Debt To Total Assets ...

    The long-term debt to total assets ratio is a measurement representing ...
  6. Primed

    Primed is when a new lender is granted a higher claims priority ...
Related Articles
  1. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  2. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
  3. Financial Advisor

    The Debt To Equity Ratio

    The debt to equity ratio identifies companies that are highly leveraged and therefore a higher risk for investors. Find out how this ratio is calculated and how you can use it to evaluate a stock.
  4. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  5. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors evaluate how energy manage their debt.
  6. Investing

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  7. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
  8. IPF - Mortgage

    What Are the Main Types of Mortgage Lenders?

    Shopping for a mortgage lender can feel confusing and a little intimidating. Understanding the differences among the main types of lenders can help you narrow down the field.
  9. Investing

    Why do Debt to Equity Ratios Vary From Industry to Industry?

    Obtain a better understanding of the debt/equity ratio, and learn why this fundamental financial metric varies significantly between industries.
RELATED FAQS
  1. What is the difference between the gearing ratio and the debt-to-equity ratio?

    Dive deeper into gearing ratios: what are they, how are they used and why the debt to equity ratio is one of the most popular ... Read Answer >>
  2. What are financial risk ratios and how are they used to measure risk?

    Explore some of the primary financial risk ratios that investors and analysts commonly use to evaluate a company's overall ... Read Answer >>
  3. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  4. How do I calculate the debt-to-equity ratio in Excel?

    Understand the basics of the debt to equity ratio, how it is interpreted as a measure of financial stability and how it is ... Read Answer >>
Hot Definitions
  1. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  2. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  3. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  4. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  5. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  6. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
Trading Center