Gearing ratio

Welcome to this session on the gearing ratio, a key concept in understanding corporate finance and risk. Gearing is all about the financial structure of a business, and it tells us how much of a company's capital comes from debt versus equity. In the United Kingdom, the term gearing is used. While in the United States, it's often called leverage. Despite the varying terminology, the underlying principle is the same. Gearing is a measure of financial risk and resilience. This ratio is an important first step when analyzing a company's financial health, as it signals how heavily a firm relies on borrowing to fund its operations and growth. Let's explore how the gearing ratio is calculated and what it reveals about a company. The most common calculation is total debt divided by total equity, though some use debt as a proportion of total capital. A higher gearing ratio means greater dependence on borrowed money, increasing financial risk. However, a moderate gearing level can enhance shareholder returns, as long as returns on borrowed capital exceed borrowing costs. Too much debt, though, can lead to financial distress if profits drop or interest rates climb. The gearing ratio matters to managers, investors and creditors because of the trade off between risk and return. High gearing often means lower initial financing costs, since debt is cheaper than equity, and interest payments are tax deductible. Yet it raises obligatory payments