# Gearing: Definition, How It’s Measured, and Example

> **Definition**
>
> Gearing, which is also known as leverage, refers to the extent to which a company is financed with debt rather than equity.

## What Is Gearing?

Gearing tells you how much of a company's operations are funded by debt versus equity or by lenders versus shareholders. This relationship is commonly measured by the [debt-to-equity (D/E)](https://www.investopedia.com/ask/answers/121614/what-difference-between-gearing-ratio-and-debttoequity-ratio.asp) ratio. Gearing is a measure of financial leverage so when the proportion of debt-to-equity is high, the business is highly geared or highly leveraged. A highly geared company can be highly profitable as long as it generates a higher return than its cost of borrowing. But, that high gearing can be risky if the company can't pay off its debts.

### Key Takeaways

*   Gearing tells investors how much of a company's operations are funded by debt over equity.
*   You can use different financial ratios to measure gearing, including a company's D/E ratio.
*   A highly-geared company can be profitable but it does come with inherent risks.

![Gearing](https://www.investopedia.com/thmb/kw3gISVuvyOp4dZG5DAnzT-aVhk=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Gearing_Final-880660361a544f1e99cb349d2d8054f4.png)

*Knowing about gearing is useful for lenders and investors since it helps them understand a company's financial health and potential risk. — Nez Riaz / Investopedia*

## Understanding Gearing

Gearing is measured by a number of ratios—including the [D/E ratio](https://www.investopedia.com/terms/d/debtequityratio.asp), [shareholders’ equity ratio](https://www.investopedia.com/terms/s/shareholderequityratio.asp), and [debt-service coverage ratio (DSCR)](https://www.investopedia.com/terms/d/dscr.asp)—which indicate the level of risk associated with a particular business. The appropriate level of gearing for a company depends on its sector and the degree of leverage of its corporate peers.

For example, a [gearing ratio](https://www.investopedia.com/terms/g/gearingratio.asp) of 70% shows that a company’s debt levels are 70% of its equity. A gearing ratio of 70% might be very manageable for a utility company—as the business functions as a monopoly, with support from local government channels—but may be excessive for a technology company, with intense competition in a rapidly changing marketplace.

## Special Considerations

Gearing, or leverage, helps to determine a company’s [creditworthiness](https://www.investopedia.com/terms/c/credit-worthiness.asp). Lenders may consider a business’s gearing ratio when deciding whether to extend it credit; to which a lender might add factors like whether the loan would be supported with collateral, and if the lender would qualify as a “senior” lender. With this information, senior lenders might choose to remove short-term debt obligations when calculating the gearing ratio, as senior lenders receive priority in the event of a business’s bankruptcy.

In cases where a [lender](https://www.investopedia.com/terms/l/lender.asp) would be offering an unsecured loan, the gearing ratio could include information about the presence of senior lenders and preferred stockholders, who have certain payment guarantees. This allows the lender to adjust the calculation to reflect the higher level of [risk](https://www.investopedia.com/terms/r/risk.asp) than would be present with a secured loan.

## Gearing vs. Risk

In general, a company with excessive leverage, demonstrated by its high gearing ratio, could be more vulnerable to [economic downturns](https://www.investopedia.com/terms/r/recession.asp) than a company that’s not as leveraged, because a highly leveraged firm must make interest payments and service its debt via cash flows, which could decline during a downturn.

On the other hand, the risk of being highly leveraged works well during good economic times, as all of the excess [cash flows](https://www.investopedia.com/terms/c/cashflow.asp) accrue to shareholders once the debt has been paid down.

## Example of Gearing

As a simple illustration, in order to fund its expansion, XYZ Corp. cannot sell additional shares to investors at a reasonable price. Instead, it obtains a $10,000,000 short-term loan.

Currently, XYZ Corp. has $2,000,000 of equity; thus, the debt-to-equity (D/E) ratio is 5×—\[$10,000,000 (total liabilities) divided by $2,000,000 (shareholders’ equity) equals 5×\]. XYZ Corp. definitely would be considered highly geared.

## How Is Gearing Measured?

A number of ratios—including the debt-to-equity (D/E) ratio, shareholders’ equity ratio, and debt-service coverage ratio (DSCR)—measure gearing. The ratios indicate the level of risk associated with a particular business.

## How Much Gearing Is Appropriate for a Company?

That depends on the business’s [sector](https://www.investopedia.com/terms/s/sector.asp) and the degree of [leverage](https://www.investopedia.com/terms/l/leverage.asp) of its corporate peers.

## How Does Gearing Apply to Credit?

Gearing helps to determine the creditworthiness of a business. Lenders may consider a company’s gearing ratio when deciding whether to provide it with credit.

## The Bottom Line

Gearing measures a company’s financial leverage. The term refers to the relationship, or ratio, of a business’s debt-to-equity (D/E). Gearing shows the extent to which a firm’s operations are funded by lenders vs. shareholders.