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What is the Gearing Ratio?

In mechanics, gears are used to increase torque and to translate the force to other areas. In finance, a gearing ratio is a term referring the amount leverage being used, compared to the amount of equity.

A high gearing ratio is almost the same as a high debt-to-equity ratio. The gearing ratio is computed in a slightly different manner. Gearing is another word for leverage. High amounts of debt can spell trouble for a company down the road, and investors are wise to consider that.

One way to visualize this is to consider that if you have a lot of gears, you certainly want to avoid wrenches (lest you should get a “wrench in the gears”). Any downturn in the economy or decrease in cash flow could mean that the company is no longer able to fulfill its debt obligations, since it may have been funding its operating expenses with debt instead of income.

Keywords: leverage, cash flow, debt-to-equity ratio, net income,