Gearing refers to the relationship, or ratio,of a company's debt-to-equity (D/E). Gearing shows the extent to which a firm's operations are funded by lenders versus shareholders—in other words, it measures a company’s financial leverage. When the proportion of debt-to-equity is great, then a business may be thought of as being highly geared, or highly leveraged.
Key Takeaways
Gearing can be thought of as leverage, where it's measured by various leverage ratios, such as the debt-to-equity (D/E) ratio.
If a company has high leverage ratios, it can be thought of as being highly geared.
The appropriate level of gearing for a company depends on its sector and the degree of leverage of its corporate peers.
Gearing is measured by a number of ratios—including the D/E ratio, shareholders' equity ratio, and debt-service coverage ratio (DSCR)—which indicate the level of risk associated with a particular business. The appropriate level of gearing for a company depends on its sector and the degree of leverage of 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% might be very manageable for a utility company—as the business functions as a monopoly with support from local government channels—but it may be excessive for a technology company, with intense competition in a rapidly changing marketplace.
Special Considerations
Gearing, or leverage, helps to determine a company's creditworthiness. Lenders may consider a business’s gearing ratio when deciding whether to extend it credit; to which a lender might add factors like whether the loan would be supported with collateral, and if the lender would qualify as a "senior" lender. With this information, senior lenders might choose to remove short-term debt obligations when calculating the gearing ratio, as senior lenders receive priority in the event of a business’s bankruptcy.
In cases where a lender would be offering an unsecured loan, the gearing ratio could include information about the presence of senior lenders and preferred stockholders, who 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 secured loan.
Gearing vs. Risk
In general, a company with excessive leverage, demonstrated by its high gearing ratio, could be more vulnerable to economic downturns than a company that's not as leveraged, because a highly leveraged firm must make interest payments and service its debt via cash flows, which could decline during a downturn. On the other hand, the risk of being highly leveraged works well during good economic times, as all of the excess cash flows accrue to shareholders once the debt has been paid down.
Example of Gearing
As a simple illustration, in order to fund its expansion, XYZ Corporation cannot sell additional shares to investors at a reasonable price; so instead, it obtains a $10,000,000 short-term loan. Currently, XYZ Corporation has $2,000,000 of equity; so the debt-to-equity (D/E) ratio is 5x—[$10,000,000 (total liabilities) divided by $2,000,000 (shareholders' equity) equals 5x]. XYZ Corporation definitely would be considered highly geared.
Gearing shows the extent to which a firm's operations are funded by lenders versus shareholders—in other words, it measures a company's financial leverage. When the proportion of debt-to-equity is great, then a business may be thought of as being highly geared, or highly leveraged.
Let's say a company is in debt by a total of $2 billion and currently hold $1 billion in shareholder equity – the gearing ratio is 2, or 200%. This means that for every $1 in shareholder equity, the company has $2 in debt. This would be considered an extremely high gearing ratio.
Simply put, it is the business's debt divided by company equity. The debt to equity ratio can be converted into a percentage by multiplying the fraction by 100. This is perhaps an easier way to understand the gearing of a company and is generally common practice.
Gearing is the ratio of a company's debt to equity. It denotes the extent to which a company's operations are funded by lenders in comparison with the shareholders. Gearing measure the company's financial leverage.
A company is said to have a high capital gearing if the company has a large debt as compared to its equity. For example, if a company is said to have a capital gearing of 3.0, it means that the company has debt thrice as much as its equity.
A high gearing ratio can be a blessing or a curse—depending on the company and industry. Having a high gearing ratio means that a company is using more debt to fund its operations, which may increase the financial risk.
Leverage refers to the amount of debt incurred for the purpose of investing and obtaining a higher return, while gearing refers to debt along with total equity—or an expression of the percentage of company funding through borrowing.
A business with a gearing ratio of more than 50% is traditionally said to be "highly geared". Something between 25% - 50% would be considered normal for a well-established business which is happy to finance its activities using debt.
A good gearing ratio depends on the industry the company sits in. While some gearing ratios above 50% are considered high risk, and others say above 100% is high risk, that figure still depends on the context it sits in. For example, a company with a gearing ratio of 60% may be perceived as high risk on its own.
to use something that you already have in order to achieve something new or better: We can gain a market advantage by leveraging our network of partners. SMART Vocabulary: related words and phrases.
Gearing is an assembly of gears designed to transmit motion. Four-speed manual gearing used to be standard in British cars. The transmission contains a number of different sets of gearing that can be changed to allow a wide range of vehicle speeds. Gearing is an assembly of gears designed to transmit motion.
Capital risk – the investment may not perform as expected resulting in a capital loss if forced to sell. Income risk – as with any loan, the investor/borrower needs to be sure they can afford to service it. If relying on investment income to service the loan, this source may not always be sufficient.
Gearing is the amount of debt – in proportion to equity capital – that a company uses to fund its operations. A company that possesses a high gearing ratio shows a high debt to equity ratio, which potentially increases the risk of financial failure of the business.
The gearing ratio is often used interchangeably with the debt-to-equity (D/E) ratio, which measures the proportion of a company's debt to its total equity.
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