Gearing ratio explained

5 minute read
|30 Jan 2025
A low-angle view of two modern skyscrapers converging towards the sky, showcasing sleek glass and metal facades. The building on the left features a smooth surface with a hint of reflection, while the building on the right displays a textured pattern with illuminated windows.
Table of contents
  • 1.
    What is a gearing ratio? 
  • 2.
    Gearing ratio formulas 
  • 3.
    How to calculate the gearing ratio 
  • 4.
    What analysis is there of the gearing ratio? 
  • 5.
    High gearing ratio vs low gearing ratio 
  • 6.
    How can you control and manage the ratio? 

Gearing ratios provide an insight into how a company funds its operations, relative to debt and equity. Using these as part of your trading fundamental analysis strategy helps to provide crucial financial ratios that can be utilised to make smarter trading decisions. Continue reading to learn about the key features of gearing ratios and how they can support your decision-making. 

What is a gearing ratio? 

Financial gearing ratios are a group of popular financial ratios that compare a company’s debt to other financial metrics, such as business equity or company assets. These represent a measure of financial leverage that determines to what degree a company’s actions are funded by shareholder equity compared to creditors’ funds. 

These ratios can be a useful part of fundamental analysis. Their calculations help provide clarity into the sourcing of a firm’s operation funding, which provides greater insight into a company’s reliability and ability to withstand periods of financial instability. 

Gearing ratio formulas 

Each gearing ratio formula is calculated differently, but the majority of the formulas include the firm’s total debts measured against variables such as equities and assets. 

Debt-to-equity ratio 

Perhaps the most common method to calculate the gearing ratio of a business is by using the debt-to-equity measure. Simply put, it is the business’s debt divided by company equity. 

Debt-to-equity ratio = total debt ÷ total equity 

The debt-to-equity ratio can be converted into a percentage by multiplying the fraction by 100. This is perhaps an easier way to understand the gearing of a company and is generally common practice. 

Debt-to-equity percentage = (total debt ÷ total equity) × 100 

Debt ratio 

Debt ratio is very similar to the debt-to-equity ratio, but as an alternative, it measures total debt against total assets. This ratio provides a measure to which degree a business’s assets are financed by debt. 

Debt ratio = total debts ÷ total assets 

Equity ratio 

Conversely, the equity ratio measures how financed a firm’s assets are by shareholder investments. Unlike the other gearing ratios, a higher percentage is often better. 

Equity ratio = total equity ÷ total assets 

How to calculate the gearing ratio 

  1. Select the company you want to analyse. These calculations will help you determine whether it may be a good investment. 

  1. Choose the type of gearing ratio. These differ in the way they're calculated. 

  1. Calculate the debt-to-equity ratio. This is the most common method, which can be done by dividing the company’s total debt by total equity. 

  1. Analyse the results. In most ratios, the higher the percentage, the more risk that is associated with the business’s operations. 

Gearing ratio example 

Let’s say that company ABC has the following financials: 

Total Debt: $100,000 

Total Equity: $400,000 

Company ABC’s debt-to-equity ratio can be calculated by taking the total debt divided by the total equity, then taking the ratio and multiplying it by 100 to express it as a percentage. 

(100,000 ÷ 400,000) ×100 = 25% debt-to-equity ratio 

What analysis is there of the gearing ratio? 

This analysis is an important aspect of fundamental analysis. Gearing ratios can differ tremendously between industries, so it is often best practice to compare them to the industry average rather than comparing companies from different industries or regions. 

Please note that the use of debt for financing a firm’s operations is not necessarily a bad thing. The extra income from a loan can help a business expand its operations, enter new markets and improve business offerings, all of which could improve profitability in the long term. 

On the contrary, a business with an extremely low gearing ratio could not be taking expansion opportunities when interest rates are low, ultimately losing out on growth opportunities that their competitors may take. Therefore, they are not a comprehensive measure of a business’s health and are just a fraction of the full picture. Make sure to use gearing ratios as part of your fundamental analysis, but not as a standalone measure and always utilise the ratios on a case-by-case basis. 

High gearing ratio vs low gearing ratio 

As mentioned above, when measuring the quality of a company’s gearing ratio, it is suggested that you measure against competitors in the same industry as they can vary wildly across industries. Below are some basic guidelines for analysing high and low ratios: 

  • A high gearing ratio that exceeds 50%. A ratio that exceeds this amount would represent a highly geared (or highly levered) company. The company would be more at risk during times of financial instability, as debt financing would increase a business’s risk during economic downturns or interest rate spikes. 

  • A mid-level ratio between 25% and 50%. A ratio that is mid-level is known to be normal for well-established companies.  

  • A low gearing ratio below 25%. Investors, lenders and any other parties analysing the financial documents would see a ratio below 25% as very low risk. 

How can you control and manage the ratio? 

There are several ways a company can try to indirectly manage and control its gearing ratio, usually by profit, debt and expense management. 

  • Debt management. Perhaps the most obvious is debt management. If a company manages their debt efficiently, they should be able to reduce their gearing ratio. Companies can take steps to pay off their debt and thus, incur less interest long term. Firms can also utilise debt management schemes to avoid taking out more loans. Additionally, firms should attempt to re-negotiate debt terms in a bid to reduce long-term liabilities. 

  • Increasing profits. Increasing profits will help increase stock price and thus, shareholder equity. Conversely, sometimes taking out loans, in this case, can help a business become more profitable in the long term. 

  • Reducing expenses will decrease liabilities and, therefore, improve the gearing ratio. Reducing expenses can include anything from renegotiating loan terms to increasing business efficiency and introducing basic cost controls. 

Join over 1,000,000 clients on our award-winning trading platform
Practise trading with $10,000 of virtual funds on a risk-free demo account.
Access 12,000+ instruments on our award-winning Next Generation platform. Including indices, forex and shares.
Enhance your trading on MetaTrader4 with CMC Markets and access 175+ forex pairs.
No hidden fees, tight spreads and low margin rates.