# Gearing Ratios: Definition, Types of Ratios, and How to Calculate

## What Are Gearing Ratios?

Gearing ratios are financial ratios that compare some form of owner's [equity](https://www.investopedia.com/terms/e/equity.asp) or capital to debt or funds borrowed by the company. Gearing is a measurement of the entity’s financial [leverage](https://www.investopedia.com/terms/l/leverage.asp) which demonstrates the degree to which a firm's activities are funded by shareholders' funds versus creditors' funds.

The gearing ratio is a measure of financial leverage that demonstrates the degree to which a firm's operations are funded by equity capital versus debt financing.

### Key Takeaways:

*   Gearing ratios are a group of financial metrics that compare shareholders' equity to company debt in various ways.
*   The goal of gearing ratios is 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're compared against the gearing ratios of other companies in the same industry.

![Gearing Ratio](https://www.investopedia.com/thmb/_Ijb9JwNlCxU7teBtWDiVm0hh4g=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Gearing-Radio-Final-00343e2fb786449ca3ef73daef057c8d.jpg)

*— Investopedia / Xiaojie Liu*

## Understanding Gearing Ratios

The best-known examples of gearing ratios include:

$\begin{aligned}&\text{Debt-to-Equity Ratio}=\frac{\text{Total Debt}}{\text{Total Equity}}\\\\&\text{Times Interest Earned}=\frac{\text{EBIT}}{\text{Total Interest}}\\\\&\text{Equity Ratio}=\frac{\text{Equity}}{\text{Assets}}\\\\&\text{Debt Ratio}=\frac{\text{Total Debt}}{\text{Total Assets}}\end{aligned}$

A higher gearing ratio indicates that a company has a higher degree of financial leverage. It's more susceptible to downturns in the economy and the [business cycle](https://www.investopedia.com/terms/b/businesscycle.asp) because companies that have higher leverage have higher amounts of debt compared to [shareholders' equity](https://www.investopedia.com/terms/s/shareholdersequity.asp). Entities with a high gearing ratio have higher amounts of debt to service. Companies with lower gearing ratio calculations have more equity to rely on for financing.

Gearing ratios are useful for both internal and external parties. Financial institutions use gearing ratio calculations when they're deciding whether to issue loans. Loan agreements may also require companies to operate within specified guidelines regarding acceptable gearing ratio calculations. Internal management uses gearing ratios to analyze future cash flows and leverage.

## Interpreting Gearing Ratios

A high gearing ratio typically indicates a high degree of leverage but this doesn't always indicate that a company is in poor financial condition. A company with a high gearing ratio has a riskier financing structure than a company with a lower gearing ratio. Regulated entities typically have higher gearing ratios because they can operate with higher levels of debt.

Companies in [monopolistic](https://www.investopedia.com/terms/m/monopoly.asp) situations often operate with higher gearing ratios because their strategic marketing position puts them at a lower risk of default. Industries that use expensive fixed assets typically have higher gearing ratios because these [fixed assets](https://www.investopedia.com/terms/f/fixedasset.asp) are often financed with debt.

> **Important**
>
> A firm's gearing ratio should be compared with the ratios of other companies in the same industry.

## Example of How to Use Gearing Ratios

Assume that a company has a [debt ratio](https://www.investopedia.com/ask/answers/121614/what-difference-between-gearing-ratio-and-debttoequity-ratio.asp) of 0.6. This figure alone provides some information as to the company’s financial structure but it's more meaningful to benchmark it against another company in the same industry.

The company's debt ratio might have been 0.3 last year. The industry average is 0.8 and the company’s main competitor has a debt ratio of 0.9. More information is derived by comparing gearing ratios to each other. A company with a 0.3 ratio is performing comparatively well in its industry when the industry average ratio result is 0.8 and the competition's gearing ratio result is 0.9,

## What Is the Times Interest Earned Ratio?

A company's [times interest earned](https://www.investopedia.com/terms/t/tie.asp) ratio is arrived at by dividing its earnings before interest and taxes (EBIT) by its interest expenses. It's a gauge of the company's ability to pay its debts each period.

## What Is Shareholders' Equity?

Shareholders' equity is the portion of a company's net assets that belongs to its investors or shareholders. It appears on the company's balance sheet. The par value of shares, anything additional in capital, retained earnings, treasury stock, and any other accumulated comprehensive income all contribute to shareholders' equity.

## What Is Financial Leverage?

A company's financial leverage is its total assets divided by its shareholders' equity. The result shows a comparison between total assets owned by the company versus shareholders' ownership. A high ratio indicates that a good portion of the company's assets are funded by debt.

## The Bottom Line

Gearing ratios compare a company’s equity to its debt. The result indicates its financial leverage or how much of its operational debt is serviced via shareholders’ equity and/or borrowed funds. It’s a strong measure of financial stability and something an investor should keep an eye on. A high gearing ratio can raise a red flag and be risky.