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    I was wondering if someone could help me on how the gearing ratio should be calculated when looking at a company's statement of financial position. For debt, should I be looking at long term debt/current debt? The company in consideration has grouped together borrowings and their bank overdraft under current liabilities, would this be a problem? The same for equity, I'm unsure of what figures I should be looking at, just the ordinary shares and reserves, or the total equity?

    Basically, a break down on what actually constitutes debt and equity in terms of the ratio would be great.
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    I was about to type in a version like this but copy and paste is so much easier.

    "What Does Gearing Ratio Mean?
    A general term describing a financial ratio that compares some form of owner's equity (or capital) to borrowed funds. Gearing is a measure of financial leverage, demonstrating the degree to which a firm's activities are funded by owner's funds versus creditor's funds.

    Also known as the Net Gearing Ratio.
    The higher a company's degree of leverage, the more the company is considered risky. As for most ratios, an acceptable level is determined by its comparison to ratios of companies in the same industry. The best known examples of gearing ratios include the debt-to-equity ratio (total debt / total equity), times interest earned (EBIT / total interest), equity ratio (equity / assets), and debt ratio (total debt / total assets).

    A company with high gearing (high leverage) is more vulnerable to downturns in the business cycle because the company must continue to service its debt regardless of how bad sales are. A greater proportion of equity provides a cushion and is seen as a measure of financial strength."
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    Thanks for the reply, I understand what gearing is and what the formula is. I just don't know what figures I should be using from the balance sheet? Non-current liabilities, current liabilities, both of them? Should I just take into consideration the shares for equity?
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    (Original post by Ariana123)
    Thanks for the reply, I understand what gearing is and what the formula is. I just don't know what figures I should be using from the balance sheet? Non-current liabilities, current liabilities, both of them? Should I just take into consideration the shares for equity?
    There is no single gearing ratio, you can use a number of different ones to show different things.

    The simplest is probably:
    All debt (current + non-current) / Shareholder's funds (this is the net asset position of the company, i.e. all assets - all liabilities).

    You could also do the current ratio. This would be:
    current debt / net current assets (i.e. current assets - current debt)

    Or you could use the US version of the gearing ratio (which in practice is limited in use) which is:
    all debt / (debt + equity)

    I would try to think of the equity as assets - liabilities rather than just as equity. This will help you understand the balance sheet a bit more as well.

    If you could say which gearing ratio that would help a bit. For equity I would use the share capital, share premium and reserve balances but again, you could arguably strip out the reserves if you wanted to analyse it based on capital employed
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    (Original post by itsmehere)
    If you could say which gearing ratio that would help a bit. For equity I would use the share capital, share premium and reserve balances but again, you could arguably strip out the reserves if you wanted to analyse it based on capital employed
    Thank you so much. This was really helpful. I'm meant to be analysing the gearing decision employed by a UK company. From what I gather from lectures etc, I need to be thinking in terms of the proportion of debt to equity to see which is more beneficial for the company and bring in theory and empirical evidence such as modigliani and miller etc.

    I've actually used the first ratio you suggested after looking at various websites, however I know a lot of my friends are using the debt/(debt + equity).

    Do you have any suggestions of books/sites that could help me with the different gearing ratios? I was hoping to include at least two within my report and was thinking of doing the gross (your first one) and the current ratio, but it has never been fully explained through uni, so I wouldn't know the first thing on how to comment on each of them.

    Sorry for the wordy reply! ^_^
 
 
 
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