If you’re looking to secure a business loan or investment, the lender or investor will check how much of your business is funded by debt compared to your own money or investors’ capital. That number is called the gearing ratio.
In this article, we’ll explain what gearing is, how to calculate your gearing ratio, why it’s important, what impacts it, and how to reduce it.
In a nutshell: The gearing ratio shows how much of your business is funded by debt compared to your own money. You can use it to check if you can safely take on more debt or if you need to reduce borrowing before applying for finance. There’s no ideal ratio, as it depends on your industry, business model, and growth plans. If you need to reduce your ratio, you can pay off debt, raise more equity, or increase profits.
What is gearing?
Gearing is the ratio of a business’s debt to its equity. You can use gearing to measure how much of your business is funded by borrowing (debt) compared to its own or its investors’ money (equity).
A highly geared business relies more on borrowed money (debt) to operate
A low geared business mostly uses its own money (equity) to operate
Note: Gearing is sometimes confused with ‘leverage’, but they’re not the same. Leverage refers to the use of debt to increase potential returns (eg taking a loan to invest in a new project), while gearing is simply the ratio of debt to equity.
What is a gearing ratio?
A gearing ratio measures how much of a business is funded by debt compared with equity. In practice, it’s usually shown as a percentage but can also be shown as a decimal.
For example, if your business has £10,000 of debt and £100,000 of equity, the gearing ratio would be 10% (or 0.1 as a decimal).
What is a good gearing ratio?
There’s no universal ‘good’ gearing ratio since so much depends on your industry, business model, and financial strategy. For example, a manufacturing business might naturally have a higher ratio than a software company because of its capital-intensive nature.
But broadly speaking, gearing ratios are typically categorised as follows:
Low gearing (under 25%): Most of your business is funded by equity, so you’re less exposed to financial risks.
Moderate gearing (25-50%): You’ve got a healthy balance between debt and equity, which is often seen as the sweet spot for stable, growing businesses.
High gearing (50-100%): You’re relying more on debt, which can work if your profits are growing. But it’s riskier if your income drops or interest rates rise.
Very high gearing (over 100%): Your debt is equal to or exceeds your equity, which can make lenders more hesitant to offer you finance.
How does the gearing ratio help businesses?
Businesses of all types and sizes can use the gearing ratio to assess their financial health and support important financial decisions.
The main benefits of using the gearing ratio include:
Helps you see if your business is relying too much on debt, so you can reduce costs or pay off loans before cash flow becomes an issue
Shows lenders and investors you’re financially responsible, which could help you secure loans or better funding terms
Enables smarter decisions about growth and risk, so you can expand at a pace your business can afford
Types of gearing ratios
Gearing ratios come in a few different forms, with each providing a different perspective on your business’s finances.
| What it shows | Why it’s useful |
|---|
| How much of your business is funded by debt compared to equity | Helps you decide if you can safely take on more debt, or if lenders will see you as high-risk and charge more or reject your application |
| What percentage of your total capital comes from debt rather than equity | Helps you spot if you’re over-reliant on debt before applying for more, so you don’t risk squeezing your cash flow or struggling with repayments |
| The portion of your assets financed through borrowing | Reveals if creditors own most of your assets, which is helpful as they’ll get paid first if asset values fall or you need to sell |
| The portion of your assets financed through equity | Shows how much of a financial cushion you have to cover losses, so lenders know you can handle tough times |
How to calculate gearing ratio (formula)
The gearing ratio is typically calculated by this formula:
Debt-to-equity ratio = (Total debt / Total equity) * 100
For example, if your business has £50,000 in total debt and £100,000 in total equity: (£50,000 / £100,000) * 100 = 50% gearing ratio
Total debt and total equity will be shown on your balance sheet. And if you use accounting software, the figures should be automatically calculated and updated as you process transactions.
Other types of gearing ratios use different formulas:
Debt-to-capital ratio = (Total debt / (Total debt + Total equity)) * 100
Debt ratio = (Total debt / Total assets) * 100
Equity ratio = (Total equity / Total assets) * 100
Gearing ratio examples
A cafe owner preparing for a loan
A cafe owner wants to expand to a second location and needs £80,000 to cover costs. Before applying for a loan, they calculate their debt-to-equity ratio to check whether they’re in a strong position to take on more borrowing.
£30,000 (debt) / £120,000 (equity) * 100 = 25% gearing ratio
Since a 25% gearing ratio shows the business isn’t over-reliant on debt, the lender sees room for more borrowing and approves the loan.
A manufacturing business with high debt
A manufacturing business has invested in new machinery. They use the debt-to-capital ratio to understand how much of their capital comes from debt before approaching investors.
£400,000 (debt) / £650,000 (debt and equity) * 100 = 61.5% gearing ratio
Over 60% of their capital is debt-funded which investors will see as high risk, so the business will need to prove their cash flow can handle repayments to secure funding.
A tech start up demonstrating financial stability
A new software business is pitching to venture capitalists. To demonstrate how much of the business is funded by its own money rather than loans, they calculate their equity ratio.
£200,000 (equity) / £250,000 (assets) * 100 = 80% equity ratio
80% of their assets are funded by owners, not debt. Investors see this as a solid financial buffer and feel confident the business would be able to absorb losses without collapsing.
What impacts your gearing ratio?
Your business’s gearing ratio doesn’t stand still and will continue to change over time. Here are some of the main things that affect it:
Business decisions: If you’re heavily focused on growing your business, you might take on more debt or equity financing, which will increase your gearing ratio. But if you’re focusing on paying off loans or retaining profits, your ratio will drop.
Economic conditions: Interest rate rises can make debt more expensive, which might force you to take on even more debt to stay afloat. Slowdowns in the economy can also put pressure on a highly geared business, as you may find it difficult to keep up with repayments if revenues fall.
Industry norms: Some industries naturally have higher gearing ratios. Capital-intensive sectors like retail and manufacturing often rely more on debt to fund their operations, for example. Similarly, some industries tend to have lower ratios, such as professional services and software development.
How can you reduce your gearing ratio?
If your gearing ratio is higher than you’d like, there are a few ways you could consider to bring it down.
Increase equity by:
Reinvesting profits back into the business instead of paying them out as dividends
Issuing new shares to bring in more equity capital
Growing sales or improving margins to boost retained earnings
Reduce debt by:
Using profits or selling assets you no longer need to pay off loans
Renegotiating loan terms to reduce interest costs and make it easier to repay debt
Wrapping up
Understanding whether your business is in a good position to raise finance or investment is a key part of running a healthy business. Calculating your gearing ratio and monitoring it regularly will help you make informed decisions about debt, equity, and growth.
Here’s a reminder of the key points:
Gearing is the ratio of your business’s debt to its equity
A gearing ratio measures this as a percentage or decimal
It’s important because it shows lenders and investors how much risk they’re taking on by funding your business
There are four main types of gearing ratios: debt-to-equity, debt-to-capital, debt ratio, and equity ratio
You can calculate it using simple formulas based on your balance sheet information
Your ratio is impacted by business decisions, economic conditions, and industry norms
You can reduce it by paying off debt, raising more equity, or increasing profits
Looking to secure a business loan? With a large panel of lenders and over £1.6 billion lent to UK businesses, Tide is here to support your growth and keep your finances in order.
FAQs
What is gearing in finance?
In finance, gearing is a way to assess how much of your business’s growth is being driven by borrowed money versus your own investment. This can help you make informed decisions about raising funding, managing risk, and planning for the future.
How can business loans affect your gearing ratio?
Business loans increase your debt, which in turn raises your gearing ratio and can make lenders more cautious. Paying loans off does the opposite, reducing your ratio and making you more attractive to lenders.
Should I aim for the lowest gearing ratio possible?
Aiming for a low gearing ratio isn’t always the right approach. The most suitable gearing level for your particular business will depend on your industry, growth stage, and strategy. For example, start ups and high-growth companies often take on more debt to scale quickly, while established businesses often prefer lower gearing to maintain cash flow.
Does a high gearing ratio mean my business is risky?
Not necessarily. High gearing can be a smart approach if you’re investing in growth and have predictable cash flow. High gearing becomes risky when you don’t have the income to cover your debts.
How often should I check my gearing ratio?
It’s a good idea to check your gearing ratio monthly or quarterly if you’re actively managing debt, before applying for new finance, or when preparing for investor meetings. For most stable businesses, reviewing it at least twice a year is a balanced approach.
What happens if my gearing ratio goes over 100%?
If your gearing ratio is over 100%, your debt will equal or exceed the equity in your business. This can make lenders more hesitant to offer finance and increase your borrowing costs.
Photo by Jakub Żerdzicki on Unsplash
