How To Calculate Gearing Ratio

Gearing ratio measures the contribution of the company's long-term debts to its long-term capital structure. The higher the gearing ratio, the greater percentage of funding that is borrowed and therefore the bigger the risk. In other words, a higher ratio is unfavorable because this indicates that the company may have difficulty in meeting its long term debt obligations.

Formula:
Gearing Ratio = [(Long term Debt / (Share capital + Reserves + Long term Debt)] * 100%
Note: Long-term debts include loans due more than one year and mortgages.

Learn how to calculate Gearing Ratio with the following example:

Peter Ltd has the following data on its balance sheet:
$1 Ordinary Shares: $800,000
General reserve: $60,000
Retained earnings: $50,000
10% Loan stock $600,000
Share premium $90,000

Therefore,
Share capital and reserves = Ordinary Shares + General reserve + Share premium + Retained earnings = 800,000 + 60,000 + 90,000 + 50,000 = $1,000,000
Gearing Ratio = [600,000 / (1,000,000 + 600,000)] * 100% = 37.5%

* Next: How to Calculate Quick Ratio
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