Gearing or leverage is the extent to which a business is funded by debt.
Gearing is usually expressed as a %.
A gearing % in excess of 100 is usually considered to be high since profit left for the shareholders becomes more volatile as the cost of debt is a pre-charge.
The standard ratio to produce the gearing % is debt divided by shareholders funds.
Debt is defined as borrowings. It excludes trade creditors. Normally debt in this context is fixed interest bearing debt but it might also need to include overdrafts if such overdrafts have become standard usage.
Shareholders funds are all assets minus all liabilities.
For safety’s sake, shareholders funds can be struck excluding goodwill, for two reasons:-
* Goodwill is historical
* Goodwill represents what was paid in the past in excess of asset valuations.