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Gearing ratio is one of the most widely used measures of financial leverage. It indicates how much of a company’s capital comes from debt compared to equity. Understanding this ratio helps in analysing financial risk and assessing whether a company is in a strong or vulnerable position when it comes to meeting its obligations.
The gearing ratio measures the proportion of a company’s borrowed funds to its equity. In simple terms, it shows how dependent a business is on debt financing as opposed to shareholder funds.
A high gearing ratio indicates greater reliance on debt, which can increase financial risk if interest costs rise. Conversely, a low gearing ratio suggests a more conservative financial structure with a higher reliance on equity.
The gearing ratio can be calculated in several ways, but the most common formula is:
Gearing Ratio = Debt ÷ Equity
Where:
Debt = Long-term loans, bonds, or borrowings
Equity = Shareholder capital and reserves
Some variations of the formula may include total capital employed (debt + equity) in the denominator to provide a broader perspective.
For example, if a company has ₹200 Crores in debt and ₹400 Crores in equity, the gearing ratio will be:
Gearing Ratio = ₹200 Crores ÷ ₹400 Crores = 0.5 or 50%.
This means that for every ₹1 of equity, the company has ₹0.50 of debt.
Different variations of gearing ratio provide insights into a company’s leverage from different perspectives.
| Variation | Formula | Key Insight |
|---|---|---|
Debt-to-Equity Ratio |
Debt ÷ Equity |
Compares debt against shareholder capital |
Debt Ratio |
Debt ÷ Total Assets |
Indicates proportion of assets financed by debt |
Equity Ratio |
Equity ÷ Total Assets |
Measures the equity contribution to total assets |
Capital Gearing Ratio |
Fixed-Interest Bearing Capital ÷ Equity |
Focuses on the proportion of fixed interest capital (like bonds and loans) to equity |
Each variation is useful depending on whether the focus is on shareholder equity, assets, or fixed liabilities.
Several factors can influence a company’s gearing ratio, making it an important metric to analyse in context.
Industry Norms: Capital-intensive industries, such as utilities or telecom, often have higher gearing ratios compared to service-oriented sectors.
Economic Conditions: During periods of low interest rates, companies may rely more on debt financing, which increases gearing.
Growth Strategy: Businesses pursuing aggressive expansion may take on more debt to fund operations or acquisitions.
Profitability: Strong earnings can reduce reliance on external borrowing, lowering gearing levels.
Although the gearing ratio provides valuable insights, it is not without limitations.
It only highlights financial structure but does not assess profitability.
A “high” or “low” gearing ratio varies significantly by industry.
It does not consider the cost of debt or the company’s ability to service interest.
Can give misleading signals during periods of fluctuating equity values.
Must be analysed with other ratios, such as interest coverage or return on equity, for a complete picture.
The gearing ratio is an essential tool for evaluating financial leverage and assessing risk in a company’s capital structure. While a high gearing ratio may indicate greater exposure to debt-related risks, a moderate level of gearing can help companies grow without overburdening shareholders. As with most financial metrics, it is most effective when used alongside other ratios and in comparison with industry benchmarks.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The gearing ratio and debt-to-equity ratio are closely related, but the gearing ratio may include broader forms of debt in relation to equity, while the debt-to-equity ratio focuses specifically on comparing total debt against shareholder capital.
Gearing ratio is calculated using the formula Debt ÷ Equity. For example, if a company has ₹300 Crores in debt and ₹600 Crores in equity, the gearing ratio will be 0.5 or 50%.
The gearing ratio is important because it shows how financially dependent a company is on debt. It helps stakeholders understand the level of financial risk and the company’s ability to meet obligations.
The term “number of gear ratios” in finance often refers to the different variations of gearing ratios, such as debt-to-equity, debt ratio, and equity ratio. Each variation provides a unique perspective on financial leverage.
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