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The gearing ratio
This measures the proportion of capital employed (i.e. the value of the business) which is funded by
longterm liabilities (i.e. the proportion of the value of the business which is interestbearing debt). It
is calculated using the following formula:
For example, if a business had longterm liabilities (loans, mortgages and debentures) totalling £3.5
million, and a 'capital employed' figure of £8.3 million, then its gearing ratio would be:
An answer of more than 50% indicates that the business is 'highly geared', since it has to make
large monthly debt repayments. This can become a problem (especially if the economy heads into a
recession or the industry goes into decline) because the business will still have to make its monthly
repayments, even though its cash inflows may be deteriorating.
A business with a gearing ratio of less than 50% is said to have 'low gearing', since its monthly
debt repayments do not form a significant proportion of its monthly outgoings.