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.