Gearing Ratio: What It Is, How to Calculate It and What It Means

What Is Gearing?

Gearing (also called leverage) measures the extent to which a company is financed by debt relative to equity. A highly geared company has borrowed heavily relative to its equity base — this amplifies returns when things go well but magnifies losses and financial risk when conditions deteriorate. Understanding gearing is essential for credit analysts, equity investors, and finance professionals assessing a company's financial risk profile.

Debt-to-Equity Ratio

The most common gearing measure: Debt-to-Equity = Total Debt / Total Equity. Where total debt includes all interest-bearing borrowings (loans, bonds, overdrafts) and total equity is shareholders' equity from the balance sheet. A ratio of 1.0 means equal debt and equity financing. Above 2.0 is generally considered high gearing for most sectors. Capital-intensive sectors like utilities and infrastructure routinely carry ratios of 2.0-4.0.

Debt-to-EBITDA

Net Debt / EBITDA is widely used by banks, credit rating agencies, and private equity: it measures how many years of EBITDA it would take to repay net debt. Most investment-grade companies target below 3.0x. PE-backed companies at acquisition often start at 4.0-6.0x and aim to delever over the hold period. Covenant tests in loan agreements are frequently structured around this metric.

Interest Cover

Interest Cover = EBIT / Net Finance Costs. Measures how many times operating profit covers the interest charge. A ratio below 2.0 indicates potential difficulty servicing debt. Banks typically require interest cover covenants of at least 3.0x. A declining interest cover ratio is an early warning sign of financial stress.

What High vs Low Gearing Means

High gearing increases financial risk — if earnings fall, the company may struggle to service its debt. But it also increases returns on equity if the company earns more on its assets than it pays in interest (positive financial leverage). Low gearing provides resilience but may indicate an inefficient capital structure. The optimal level of gearing depends on the stability of the business's cash flows, the asset base, and prevailing interest rates. Gearing analysis is examined in ACCA FM and AFM and CIMA F3.