CandleFocus

Gearing

Candlefocus Editor
Gearing is a business finance tool used to measure a company's financial leverage, or its use of borrowing to help fund its operations. Gearing is calculated by various leverage ratios, such as the debt-to-equity (D/E) ratio, which takes into account how much of a company's equity and debt it is using to fund its activities. A company's respective D/E ratio is calculated by dividing its total debt by its shareholders' equity. A higher D/E ratio generally indicates that a company is more highly geared.

Gearing can be a very powerful tool, since it can help a company fund large scale expenses and capital investments, such as in the case of building new factories and purchasing new equipment, more easily and quickly. This, in turn, can result in increased profits.

At the same time, there are also risks associated with high levels of gearing. If profits start to decline, the company may not be able to service its debt or pay its shareholders dividends. This could hamper the company's ability to grow or even lead to bankruptcy.

So how much gearing is appropriate for a company? This depends on a number of factors, including its industry and the leverage of its competitors. In higher risk industries, such as natural resources, higher levels of gearing may be needed to create the returns that investors are looking for. On the other hand, lower risk sectors, such as utilities, may require lower levels of gearing.

It is important to remember, however, that while gearing can result in higher returns, there is also an increased risk of returns failing to meet expectations should profits decline. Companies should also ensure that their high levels of gearing and liquidity are sustainable, so as to maintain their credit-worthiness and ability to access additional capital should the need arise.

Overall, gearing can be an effective tool for companies to pursue bigger investments, taking full advantage of their financing opportunities, as long as they remain aware of its associated risks, view gearing in the context of their respective sector, and stick to what they can comfortably manage.

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