Gearing Ratio evaluates the financial structure of the company. It indicates the ratio of capital raised through debt to that raised through equity. In other words, it is the measure of financial leverage of a company. It is also known as Debt-Equity Ratio.
It can be computed by dividing the company’s total debt (both long-term as well as short term obligations) with the shareholders’ equity. Thus,
Gearing Ratio/Debt-Equity Ratio = Total Debt/ Total Equity
For e.g.: A company has a total capital investment of Rs.1 crore out of which Rs. 40 lakhs have been raised through loans and remaining through issuing equity shares. Then the gearing ratio of company comes out to be = 0.67 (40,00,000 / 60,00,000).
Significance of Gearing Ratio:
This ratio is significant with the view of assessing company’s financial position and its future ability to meet its fixed obligations. A higher gearing ratio implies more risk of default by the company due to more burden (in form of fixed interest payments) on its earnings. That is why, this ratio is very important while raising additional loan. Generally a ratio of more than 0.5 is considered high by the financial institutions. But more importantly a company’s ability to raise a loan depends upon the fact that how well it manages its funds and avoids default of payment.
Loan Frame assesses your gearing ratio along with the financial position of your company by carefully looking at its past record and its potential to generate more revenue from the additional funds raised. We then provide you the best business loan options.
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