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Gearing Formula (Table of Contents)

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What is the Gearing Formula?

The term “gearing” refers to the group of financial ratios that demonstrate to what degree a company’s operations are funded by debt financing vs equity capital. In other words, the metrics signify the mix of funding from lenders and shareholders. There are three major gearing ratios –

Debt-to-Equity Ratio

Equity Ratio

Debt Ratio

The formula for the debt-to-equity ratio is expressed as the company’s total debt divided by its total equity. Mathematically, it represents as,

Debt-to-Equity Ratio = Total Debt / Total Equity

The formula for equity ratio is expressed as the company’s total equity divided by its total assets. Mathematically, it represents as,

Equity Ratio = Total Equity / Total Assets

The formula for debt ratio is expressed as the company’s total debt divided by its total assets. Mathematically, it represents as,

Debt Ratio = Total Debt / Total Assets

Examples of Gearing Formula (With Excel Template)

Let’s take an example to understand the calculation of Gearing in a better manner.

You can download this Gearing Formula Excel Template here – Gearing Formula Excel Template

Gearing Formula – Example #1

Let us take the example of a company with the following information retrieved from its annual report: Calculate its gearing ratio based on the given information.

Solution:

Debt-to-Equity Ratio calculates by using the formula given below

Debt-to-Equity Ratio = Total Debt / Total Equity

Debt-to-Equity Ratio = $35 million / $25 million

Debt-to-Equity Ratio = 1.40x

Equity Ratio calculates by using the formula given below

Equity Ratio = Total Equity / Total Assets

Equity Ratio = $25 million / $75 million

Equity Ratio = 0.33x

Debt Ratio calculates by using the formula given below

Debt Ratio = Total Debt / Total Assets

Debt Ratio = $35 million / $75 million

Debt Ratio = 0.47x

Therefore, the company’s debt-to-equity, equity, and debt ratios are 1.40x, 0.33x, and 0.47x, respectively.

Gearing Formula – Example #2

Let us take an example of more detailed financial information to illustrate the computation of gearing ratios. Use the following information to compute the gearing ratios:

Solution:

Total Debt calculates by using the formula given below

Total Debt = Long-Term Debt + Short-Term Debt

Total Debt = $50,000 + $20,000

Total Debt = $70,000

Debt-to-Equity Ratio calculates by using the formula given below

Debt-to-Equity Ratio = Total Debt / Total Equity

Debt-to-Equity Ratio = $70,000 / $150,000

Debt-to-Equity Ratio = 0.47x

The Equity Ratio calculates by using the formula given below

Equity Ratio = Total Equity / Total Assets

Equity Ratio = $150,000 / $230,000

Equity Ratio = 0.65x

Debt Ratio = Total Debt / Total Assets

Debt Ratio = $70,000 / $230,000

Debt Ratio = 0.30x

Therefore, the company’s debt-to-equity, equity, and debt ratios are 0.47x, 0.65x, and 0.30x, respectively.

Gearing Formula – Example #3

Let us take the example of Apple Inc. and calculate the gearing ratios according to the annual report’s financial report for 2023. The following is available:

Solution:

Total Debt calculates by using the formula given below

Total Debt = Commercial Paper + Term Debt

Total Debt = $11,964 million + $102,519 million

Total Debt = $114,483 million

Debt-to-Equity Ratio calculates by using the formula given below

Debt-to-Equity Ratio = Total Debt / Total Equity

Debt-to-Equity Ratio = $114,483 million / $107,147 million

Debt-to-Equity Ratio = 1.07x

The Equity Ratio calculates by using the formula given below

Equity Ratio = Total Equity / Total Assets

Equity Ratio = $107,147 million / $365,725 million

Equity Ratio = 0.29x

Debt Ratio calculates by using the formula given below

Debt Ratio = Total Debt / Total Assets

Debt Ratio = $114,483 million / $365,725 million

Debt Ratio = 0.31x

Therefore, Apple Inc.’s debt-to-equity ratio, equity ratio, and debt ratio for the year 2023 were 1.07x, 0.29x, and 0.31x, respectively.

Screenshot of balance sheet used for calculation

Source Link: Apple Inc. Balance Sheet

Explanation

The formula for different gearing ratios can be derived by using the following steps:

Step 1: Firstly, determine the total debt of the company, which is the aggregate of all long-term and short-term interest-bearing liabilities such as term loans, working capital loans, capital leases, etc.

Step 2: Next, determine the company’s total equity, also known as shareholder’s equity.

Step 3: Next, determine the company’s total assets, the sum of all capitalized resources employed in the business.

Step 4: The formula for a debt-to-equity ratio can be derived by dividing total debt (step 1) by total equity (step 2), as shown below.

Debt-to-Equity Ratio = Total Debt / Total Equity

The formula for the equity ratio can be derived by dividing total equity (step 2) by total assets (step 3), as shown below.

Equity Ratio = Total Equity / Total Assets

The formula for debt ratio can be derived by dividing total debt (step 1) by total assets (step 3). Mathematically, it represents as,

Debt Ratio = Total Debt / Total Assets

Relevance and Use of Gearing Formula

It is important to understand the concept of gearing ratios because most lenders and analysts use these financial ratios to assess an entity’s degree of leverage. Typically, a higher value of equity ratio and lower value of debt-to-equity ratio and debt ratio indicates sound financial health. However, please note that the gearing ratios should be compared among companies operating in the same industry, as these ratios are very industry-specific.