Personal Finance. Your Practice. Popular Courses. Financial Ratios Guide to Financial Ratios. What Is the Gearing Ratio? Key Takeaways: Gearing ratios are a group of financial metrics that compare shareholders' equity to company debt in various ways to assess the company's amount of leverage and financial stability. Gearing is a measure of how much of a company's operations are funded using debt versus the funding received from shareholders as equity.
Gearing ratios have more meaning when they are compared against the gearing ratios of other companies in the same industry. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. What Is a Solvency Ratio? Understanding Total-Debt-to-Total-Assets Total-debt-to-total-assets is a leverage ratio that shows the total amount of debt a company has relative to its assets. Leverage Ratio A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or that assesses the ability of a company to meet financial obligations.
But as a one-time calculation, gearing ratios may not provide any real meaning. It's also important to remember that although high gearing ratio results indicate high financial leverage, they don't always mean that a company is in financial distress.
While firms with higher gearing ratios generally carry more risk, regulated entities such as utility companies commonly operate with higher debt levels. When looking at a company's gearing ratio, be sure to compare it to that of similar businesses. Monopolistic companies often also have a higher gearing ratio because their financial risk is mitigated by their strong industry position.
Additionally, capital-intensive industries, such as manufacturing, typically finance expensive equipment with debt, which leads to higher gearing ratios.
For this reason, it's important to consider the industry that the company is operating in when analyzing it's gearing ratio, because different industries have different standards. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile. Measure ad performance. Select basic ads. Create a personalised ads profile.
Utilities have a monopoly in their market-making their debt less risky than a company with the same debt levels, which operates in a competitive market. Typically, a low gearing ratio means a company is financially stable, but not all debt is bad debt. It's essential for companies to manage their debt levels.
However, it's also important that companies put their assets on their balance sheets to work, including using debt to boost earnings and profits for their shareholders. A safe gearing ratio can vary from company to company and is largely determined by how a company's debt is managed and how well the company is performing. Many factors should be considered when analyzing gearing ratios such as earnings growth, market share, and the cash flow of the company.
It's also worth considering that well-established companies might be able to pay off their debt by issuing equity if needed. In other words, having debt on their balance sheet might be a strategic business decision since it might mean less equity financing. Fewer shares outstanding can result in less share dilution and potentially lead to an elevated stock price.
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These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. A company with a high gearing ratio will tend to use loans to pay for operational costs, which means that it could be exposed to increased risk during economic downturns or interest rate increases.
This could lead to financial difficulties, and even bankruptcy. A company with a low gearing ratio will generally have more conservative spending habits or operate in a cyclical industry — one that is more sensitive to economic ups and downs — so it tries to keep its debts down. Companies can reduce their gearing ratio by paying off their debts.
There are multiple ways to do this, including:. A gearing ratio is a useful measure for the financial institutions that issue loans, because it can be used as a guideline for risk. When an organisation has more debt, there is a higher risk of financial troubles and even bankruptcy. Gearing ratios are also a convenient way for the company itself to manage its debt levels, predict future cash flow and monitor its leverage. This is because the gearing ratio could reflect a risky financial structure, but not necessarily a poor financial state.
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