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Understanding Gearing Ratios in Finance

Gearing ratio is a measure of a company's financial leverage and is calculated by dividing total debt by either shareholders' equity or total capital. It is commonly known as the debt-to-equity ratio when calculated using shareholders' equity and the debt-to-capital ratio when calculated using total capital. Total debt includes both long-term and short-term interest-bearing debt as well as other liabilities like pension obligations and capital leases. In addition to gearing ratios, a company's financial leverage is also analyzed using interest coverage, degree of operating leverage, degree of financial leverage, and degree of total leverage ratios.

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824 views1 page

Understanding Gearing Ratios in Finance

Gearing ratio is a measure of a company's financial leverage and is calculated by dividing total debt by either shareholders' equity or total capital. It is commonly known as the debt-to-equity ratio when calculated using shareholders' equity and the debt-to-capital ratio when calculated using total capital. Total debt includes both long-term and short-term interest-bearing debt as well as other liabilities like pension obligations and capital leases. In addition to gearing ratios, a company's financial leverage is also analyzed using interest coverage, degree of operating leverage, degree of financial leverage, and degree of total leverage ratios.

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DivineDavis
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We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd

Gearing ratio is a measure of a company’s financial leverage i.e.

the level of interest-bearing liabilities in


its capital structure. Gearing ratio is most commonly calculated by dividing total debt by shareholders
equity. Alternatively, it is also calculated by dividing total debt by total capital.

Formula

When gearing ratio is calculated by dividing total debt by total assets, it is also called debt to equity ratio.

Following is the most common formula for gearing ratio:

Gearing RatioDE

The gearing ratio calculated by dividing total debt by total capital (which equals total debt plus
shareholders equity) is called debt to capital ratio.

Debt to Capital Ratio DDE

Where D is the total debt is defined as the sum of interest-bearing long-term and short-term debt such as
bonds, bank loans, etc. It also includes other interest-bearing liabilities such as pension obligations,
capital leases (also called finance leases), etc. E stands for shareholders equity which includes common
stock, additional paid-up capital, retained earnings, irredeemable preferred stock, etc.

In addition to the capital structure ratios above, a company’s gearing is also analyzed using the interest
cover ratio, degree of operating leverage ratio, degree of financial leverage ratio, degree of total leverage
ratio and financial break-even point.

Example

Give the following data for the last five years for Walmart Inc. (NYSE: WMT), use the gearing ratios to
analyze the company’s long-term financial viability:

USD in million 2014 2015 2016 2016 2018


Total assets 204,751 203,706 199,581 198,825 204,522
Liabilities and stockholders' equity
Current liabilities
Short-term debt 11,773 6,402 5,453 3,355 8,995
Capital leases 309 287 551 565 667
Accounts payable 37,415 38,410 38,487 41,433 46,092
Taxes payable 3,520 3,613 3,065 3,737 3,718
Accrued liabilities 12,762 13,254 13,649 13,916 13,295
Deferred revenues 2,017
Other current liabilities 3,566 3,306 3,414 3,922 3,737
Total current liabilities 69,345 65,272 64,619 66,928 78,521
Non-current liabilities
Long-term debt 41,771 41,086 38,214 36,015 30,045
Capital leases 2,788 2,606 5,816 6,003 6,780
Deferred taxes liabilities 8,017 8,805 7,321 9,344 8,354
Minority interest 5,084 4,543 3,065 2,737 2,953
Other long-term liabilities 1,491
Total non-current liabilities 59,151 57,040 54,416 54,099 48,132
Total liabilities 128,496 122,312 119,035 121,027 126,653
Total stockholders' equity 76,255 81,394 80,546 77,798 77,869

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