What Is Gearing? A Simple Definition
Gearing is a popular word in the financial world. It is a synonym of ‘financial leverage’ and both of these words can be used interchangeably. This is a ratio between the amount of own and the amount of borrowed capital in a business, personal budget or any other financial unit. To learn more about leverage in finance, you can read our example on this matter here.
As we said earlier, gearing ratio is the percentage of own funds from borrowed funds. An example of this is the debt to equity ratio from corporate finance. Let’s say that a company has $12 000 of equity and has borrowed $20 000 in debt. Such a company would have $32 000 of total assets ($12000 + $20000). We can find its debt to equity ratio this way:
Equity / Total Debt = 12 000 / 20 000 = 3/5 .
In this example, we can say that this business has a leverage or gearing ratio of 3/5.
More Gearing Ratios
Except for this one, there are some more gearing ratios. Some of them are:
Current Assets / Current Liabilities = Current Ratio
Total Debt / Total Assets
…. more about leverage ratios you can read here:
The most important thing you should know about leverage is that it measures the level of debt in a company or other financial system. The more debt compared to own assets a company has, the riskier its business is considered. Therefore, higher levels of leverage mean more risk taken from the management.