Gearing focuses on long term liquidity and shows whether a firm’s capital structure is likely to continue to meet interest payments and repayments on long term borrowing.
Capital structure — What proportions of capital originate from each source
Two ways of measuring gearing
- Debt/equity ratio
- Gearing ratio
Debt to equity ratio (%)
Debt/Equity * 100
- Higher is riskier
- Higher can lead to much more profit, or much more catastrophic failure
- Lower is safer, but earnings are unlikely to spike
- The best choice depends on the business
Gearing ratio (%)
Non-current liabilities / Total equity + non-current liabilities * 100
Evaluating
- If ratio is 50% or above, normally said to be high
- Gearing of less than 20% normally said to be low
- But levels of acceptable gearing depend upon the business and industry
- 50%
- 20%