BAJAJ BROKING
July 04, 2025
4 mins read
The gearing ratio is also a crucial financial indicator that can be used to assess a firm's capital structure by comparing its debt to equity. It indicates the proportion of the company's financing that comes from borrowed money and shareholder capital. The gearing ratio is crucial for business owners, investors, and analysts because it reveals the degree of financial risk and stability that a company faces. A balanced level of gearing ratio seems to denote a well-balanced proportion between debt and equity. Its high or very low level may raise apprehension.
Read further to learn what gearing ratio is, how it is measured, and why it matters across differing industries and scenarios.
The gearing ratio is a tool employed to comprehend the extent to which a company relies on borrowed capital compared to its own capital. It displays the ratio of debt over equity, allowing us to observe to what extent the business is financed through loans rather than shareholders' capital.
If a company has a high gearing level, it implies that it has borrowed a great deal. This will imply financial risk, depending on the sector. Certain businesses, such as those in the utilities or infrastructure sectors, tend to use more debt, whereas others in volatile markets prefer less.
The common formula is:
Gearing Ratio = (Total Debt / Shareholders’ Equity) × 100
Example:
If a company has ₹10 crore in debt and ₹25 crore in equity:
(10 / 25) × 100 = 40%
This means 40% of its operations are funded by debt.
Add up all the company’s debts (both short- and long-term).
Calculate shareholders’ equity (total assets minus total liabilities).
Use the formula: (Total Debt / Shareholders’ Equity) × 100
Read the result as a percentage, it reflects how much the company relies on debt.
A good ratio is determined by the industry and the company's strategy. Normally, if gearing is below 50%, that's quite a good position. It indicates that the business does not rely heavily on borrowed funds.
However, some industries tend to have naturally higher gearing ratios. For example, capital-intensive industries such as power or telecommunications might have more debt on their books, as they also have stable revenue streams. Conversely, organisations dealing in cyclic industries might prefer low gearing to remain agile during downturns.
Additionally, the cost of borrowing is a significant factor. A company with high gearing might not face problems if it gets low-interest loans. Companies with low gearing might still struggle if they must borrow at high interest rates.
Typically, a ratio between 25% and 50% is regarded as good. It depicts a healthy proportion of equity and debt. It enables the company to utilise borrowed funds with effectively managed risks. Healthy gearing brings tax savings on interest payments and improved returns.
Anything above 50% can be risky, especially if it’s not common in that industry. This means the company is heavily reliant on debt, which can be hazardous if cash flow declines or interest rates rise. This could even lead to financial trouble or bankruptcy. On the other hand, very low gearing could mean the company isn’t taking advantage of opportunities to grow using leverage.
It is crucial to weigh the pros and cons of gearing before you can use the tool to its potential.
Gearing ratios enable lenders and financial institutions to quickly assess the risk associated with lending to a company. A high gearing ratio typically indicates a greater risk of financial difficulties or even bankruptcy.
For businesses, it’s a handy tool to track their debt levels, plan future cash flow, and manage their financial leverage more effectively.
However, gearing ratios do have limits. A high ratio might suggest financial risk, but it doesn’t always mean the company is struggling. The ratio alone doesn’t tell the full story. It’s more useful when compared to past data or to other companies in the same industry.
Gearing tools can be effectively used by the following:
Banks and lenders examine gearing ratios to determine whether to extend loans. Since their goal is to earn interest payments, they want to ensure that a borrower can repay them.
Startups with high gearing often get rejected because they carry higher financial risk. But some firms, like those in energy or utilities, can handle higher debt due to the steady nature of their business.
Investors also consider gearing ratios when evaluating a company. A low gearing ratio typically indicates that the company is on solid financial footing, which can attract more investment. If a company already has a significant amount of debt and is paying high interest, potential investors might hesitate, fearing that their money won’t generate good returns or could be at risk.
Gearing ratios are particularly useful when comparing similar companies. A single number might appear risky on its own, but when viewed alongside others in the same sector, it can tell a different story.
For instance, if a firm has a gearing ratio of 60%, it may seem high. But if competitors are operating at 70% or 80%, that 60% suddenly looks more reasonable and even competitive.
To reduce their gearing ratio, companies need to decrease the amount of debt they owe. Here are a few common ways they can do that:
By selling additional shares to the public, a company can raise capital and increase its equity, which can then be used to repay debt.
Sometimes, companies work out deals with lenders to turn existing loans into shares, reducing their outstanding debt.
Lowering everyday costs by eliminating inefficiencies can free up cash that can be used to pay back loans.
Focusing on strategies to increase revenue can lead to higher profits, allowing the company to reduce its debt load with more financial resources.
Gearing ratios are helpful for anyone looking to understand a company’s financial position, whether it’s a lender, investor, or the business itself. They demonstrate the extent to which a company relies on borrowed money and help assess the level of financial risk.
Still, it’s essential not to rely solely on this ratio. It’s rather useful when viewed over time and compared with industry peers. Together with other financial indicators, gearing ratios offer a clearer picture of a company’s overall health.
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A low gearing ratio means a company uses less debt and more equity to finance its operations. This typically indicates financial stability and lower risk, as the business isn't heavily dependent on borrowed money to operate.
The gearing ratio indicates the proportion of a company’s capital that is financed through debt compared to equity. A higher ratio indicates a greater risk due to debt, while a lower ratio suggests a safer, more equity-backed financial structure.
The gearing ratio is calculated as follows: Gearing Ratio = (Total Debt / Total Equity) or (Debt / (Debt + Equity)), depending on the method used. It's usually expressed as a percentage to show leverage.
An ideal gearing ratio depends on the industry, but generally, 25% to 50% is considered healthy. It exhibits a balanced mix of debt and equity, enabling growth without incurring excessive financial risk.
You can lower your gearing ratio by reducing debt, issuing more equity, or increasing retained earnings. Paying off loans or improving profits also helps reduce reliance on borrowed funds, making the business more stable.
A gearing ratio of 0.5 means that for every ₹1 of equity, the company has ₹0.50 in debt. It indicates moderate leverage and suggests the company isn’t overly dependent on borrowed money for its operations.
A high gearing ratio indicates that the company has more debt than equity. This raises financial risk, particularly if earnings decline or interest rates increase. However, it can also mean faster growth if the borrowed money is used wisely.
Yes, a 30% gearing ratio is generally considered good. It means the company has a low level of debt relative to equity, which often signals strong financial health and less risk during economic downturns.
Not always. A high gearing ratio can help fuel growth but it increases financial risk. A low ratio indicates stability, but it may limit the ability to expand. The right choice depends on the company’s goals, industry, and market conditions.
The gearing ratio helps assess financial risk and capital structure. It reveals the extent to which a company relies on debt, helping investors assess whether the firm can effectively manage downturns or rising interest costs.
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