Formula of the Gearing Ratio (Example)

There are different representations of  gearing ratio formula with example. The ratio that is calculated is similar however the representation of the formula is different. Below are the few representations of the formula of the gearing ratio. 

Gearing Ratio = Long Term Debt/ Share Holder Equity
Gearing Ratio = Long Term Liabilities/ Capital Employed
Capital Gearing Ratio = Equity Share Capital/ Fixed Interest accepting Funds

Gearing ratio is further used to calculate the Gearing ratio percentage. The gearing ratio percentage can be calculated as:-
Gearing Ratio Percentage = Long Term Liabilities/ Capital Employed x 100
In the above mentioned formula the long term liabilities include loans due within more than one year, shares and mortgages. Where as capital employed includes distributed capital, retained earnings and long term liabilities.
Example to Calculate Gearing Ratio
The table contains the data to calculate gearing ratio

2012 ($,000)
2011 ($,000)
Long Term Liabilities
Capital Employed
Gearing Ratio
The table shows that the gearing ratio in the year 2011 was 31.0 percent where as in 2012 the gearing ratio decreased to 21.2 percent. The decrease in the gearing ratio is due to the decrease in the long term liabilities of the firm and increase in the working capital of the firm.

Another formula to calculate gearing ratio can be introduced as under:-
Gearing Ratio = (Long Term Borrowings+ short term loans +overdraft) – cash /Share Holders Funds x 100
The above mentioned formula shows that gearing ratio is the measure of the financial leverage of a company. Here we are calculating gearing ratio by using company’s long term borrowing and dividing it with the total funds provided by the share holders. Gearing ratio can also be calculated as simple debt to equity ratio as mentioned above.

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How to reduce Gearing Ratio of Company

A low gearing ratio indicates that company is financially stable and there is low risk of being liquidated associated with the company. However, in reality a company can not expand its operations without having long term debt and creditor funding. A company can invest loans and funds taken from creditors in more profitable projects that will return more cash flow for the company and will increase the percentage of owner’s equity in the business operations. A company will low gearing ratio can easily get further loans from the market as creditors are sure that company will be able to pay the interest payments. There are a number of ways of reducing the gearing ratio of  a company. 

One of the best ways to reduce the gearing ratio is to sell the shares of the company. The board of directors and management of the company must allow the selling of the shares in order to pay the debt. However, the ratio of the shareholders must be kept acceptable as the higher ratio of the share holders indicates that the company belongs to its share holders more relatively as compared to the original owners. 

Another way of reducing gearing ratio of the company is the method of converting loans. This can be done by asking the lenders to convert their loans into the shares of the company and become the shareholder of the company. Another method to reduce gearing ratio is to reduce the amount of working capital and this can be done by enhancing the speed of collecting accounts receivables, lowering the level of inventory and extending the time period required to pay the accounts payable. These methods are used to produce cash and the cash can be used to pay off debt in order to reduce the gearing ratio. Another way to reduce gearing ratio is to increase the profit and pay that profit in order to reduce the loans and debt.

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