Definition Gearing Ratio. Description.
The Gearing Ratio measures the percentage of capital employed
that is financed by debt and long term finance. The higher the gearing, the
higher the dependence on borrowings and long term financing. The lower the
gearing ratio, the higher the dependence on equity financing. Traditionally,
the higher the level of gearing, the higher the level of financial risk due
to the increased volatility of profits. Utilizing gearing amplifies the potential
gain from an investment or project, but also increases the potential loss.
The Gearing Ratio is calculated as follows: divide Long Term
Liabilities by (Equity + Long Term Liabilities) X 100 which results in a percentage.
Note that in the USA the term "Leverage" or "Financial Leverage" is more commonly
used.
In certain Financial Debt Covenants, the borrower may be obliged to maintain a certain gearing ratio.
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When is Gearing Ratio High or Low?
"Hi, I was just wondering. The article says "the higher the gearing ratio...." or "the lower the gearing ratio..." but I was wondering what deemed a high or a low ratio. Specifically, what is a high ratio? Over 2?" |
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Compare also:
Debt to Equity Ratio |
Recapitalization |
Undercapitalization
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