Gearing Ratio Tool

A Gearing ratio shows the ratio between the amount of capital provided by shareholders or through government grants (equity) and those lending money to the firm in the form of credit of one type or another (debt).

If the debt is greater than the reserves, the business is highly geared. If the reserves are greater than the debt, the business is lowly geared. For most businesses it is preferable to be low geared as this puts less strain on the profits of the business. Just fill in your figures in the boxes below and your Gearing Ratio will be calculated.

Gearing Ratio Tool

Gearing Ratio = Net Debt/ Reserves

Gearing Ratio

Net Debt, net of cash deposits Reserves includes share capital and government grants, if any

Note:
This information is provided for illustrative purposes only and is based on the accuracy of information provided. It does not constitute a contract. We are not recording and will not use the information quoted by you in our calculators unless it is being used as part of a product application.

FAQ's about Gearing Ratio's

Why is the Gearing Ratio useful?
The Gearing Ratio is useful as it provides information about one aspect of an organisation's risk; it's financial risk. A highly geared business could face the following potential problems:
- In times of low profits the ordinary shareholders may receive no dividends, due to the high level of fixed interest payments which put a strain on profits.
- The company may find it hard to raise further finance, and banks and other financial institutions may be reluctant to lend the business further funds.
- In the case of a public limited company (plc), share prices may fall as ordinary shareholders begin to sell their shares.
- If profits are poor, the business may not be able to pay the interest due on its fixed interest capital. Therefore any assets used as security would be at risk.
Is it acceptable for a business to be highly geared?
In certain situations it may be acceptable for a business to be highly geared:
- If the borrowed funds can be used in the business to make a higher return than that paid to the lenders of the funds.
- If there was a desire within the business to have no further loss of control, i.e. by issuing more ordinary shares a business is introducing new shareholders who will have a say in the running of the business. By raising finance through borrowing, the lenders rarely have a say in the running of the business.
- If the company is going through a highly profitable phase and profits are well able to cover all fixed interest capital obligations and still leave a surplus available to the ordinary shareholders.
- If interest rates are low, it may be wise for a business to borrow funds rather than issue shares.
We apply a number of ratios to lending proposals and would be happy to explain how the Bank uses Gearing Ratios. For further information on the Gearing Ratio, please your Relationship Manager.