GEARING is the proportion of the capital employed in a company that is financed by lenders rather than shareholders. In simple terms, explains how a company finances its operations either through lenders or through shareholders. Gearing is basically defined as the ratio between a company’s borrowing (debt) and owner’s equity (i.e. shareholder’s fund). It is synonym to the word financial leverage. The ratio explains the degree to which the business is funded by the owner as against the borrowed funds. The gearing ratio shows how restrain a company is with debt. Companies with high gearing more long term liabilities than shareholder equity are considered speculative. The gearing ratio helps you to examine the capital structure of the company. It summarizes the proportion of debt (loans etc.,) and equity (from shareholders). If a company is having high gearing means the company is taking risk through having high level of debt compared to its equity.
Gearing Ratio = (loan capital + preference share capital) / (total capital (loan + preference + equity))
Gearing Ratio = Total Borrowings / (Total Borrowings + Total Equity) * 100
Debt includes only borrowing, not other debt such as trade creditors. Subtract goodwill from the value of shareholders’ funds when calculating gearing as goodwill reflects a company’s history rather than its current financial strength.