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Gearing Ratio

"The company has a gearing ratio of 0.8x ”
What does this means?

This basically means that the company’s debt levels are at 80% of its equity.
Gearing ratio is simply a financial ratio that describes the level of a company’s debt to its equity. It gives us an idea about the company leverage, whether the company is funded more by owners’ fund (equity) or creditors’ fund (debt). Thus, it is sometimes known as debt-equity ratio.

Consider the following cases of low gearing and high gearing company.

Company A has a low gearing ratio of 10%. This means that the company has 10 times more equity than the debt. Hence, this company is less risky as it would be able to pay off the debt nearly 10 times before facing any difficulties.

On the other hand, company B has a high gearing ratio of 80%. A company like this is very risky, as a reduce in profit or even increase in debt’s interest could affect the financial position of company. Furthermore, company with high gearing ratio is normally more susceptible to economic downturn, when everyone wants to retrieve and hold cash on their hands.

The acceptable gearing ratio varies for different industries. A 70% gearing ratio is unacceptably high for technology companies, but is fine for utility company. Hence, in order to judge whether a gearing ratio is high or low, one must compare it with the peers in the same industry.

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