methods of improving gearing

10.2 Analysis of Published Accounts – Gearing Ratio 📊

What is the Gearing Ratio?

The gearing ratio tells us how much of a company’s capital comes from borrowing compared to its own funds. It’s a quick way to gauge financial risk.

Interpreting the Ratio

1. Low Gearing (e.g., < 0.5): The company relies more on its own money – safer but may miss growth opportunities.
2. Moderate Gearing (≈ 0.5–1.0): Balanced use of debt and equity – common for many businesses.
3. High Gearing (> 1.0): More debt than equity – higher risk of default, but can boost returns if profits rise.

How to Improve Gearing (Lower the Ratio)

• 🔧 Reduce Debt: Pay down loans or refinance at lower rates.
• 💰 Increase Equity: Issue new shares or retain more earnings.
• 📈 Boost Profitability: Higher profits increase equity without extra debt.
• 🧩 Re‑structure Capital: Convert short‑term debt to long‑term or swap debt for equity.
• 📉 Control Costs: Lower operating expenses to free up cash for debt repayment.

Example Calculation

Suppose a company has:

• Long‑term debt = £200,000
• Equity = £400,000

Gearing Ratio = $ \displaystyle \frac{200,000}{400,000} = 0.5 $ – a moderate level.

If the company pays off £50,000 of debt and retains £30,000 of earnings:

• New debt = £150,000
• New equity = £430,000

New Gearing Ratio = $ \displaystyle \frac{150,000}{430,000} \approx 0.35 $ – the company is now less leveraged.

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