The gearing ratio, also known as the leverage ratio, is a financial metric that measures the proportion of a company’s capital that is financed through debt relative to equity. It provides insight into the financial structure of a business and the extent to which it relies on borrowed funds.

The gearing ratio is calculated using the following formula:

\[ \text{Gearing Ratio} = \left( \frac{\text{Debt}}{\text{Equity + Debt}} \right) \times 100 \]

– \( \text{Debt} \) represents the total debt of the company.
– \( \text{Equity} \) represents the shareholders’ equity or net assets.

The result is usually expressed as a percentage.

### Interpretation of the Gearing Ratio:

1. **High Gearing Ratio:**
– Indicates that a significant portion of the company’s capital is financed through debt.
– May amplify returns on equity when the company is profitable.
– Increases financial risk, as interest payments and debt obligations must be met even during challenging economic conditions.

2. **Low Gearing Ratio:**
– Suggests that the company relies more on equity financing.
– Reduces financial risk but may limit the company’s ability to benefit from financial leverage for potential growth.

3. **Balancing Risk and Return:**
– Gearing reflects the trade-off between risk and return. High gearing may lead to higher returns on equity in favorable conditions but can increase financial vulnerability.

4. **Investor Considerations:**
– Investors and analysts use the gearing ratio to assess the financial risk of a company and determine its capital structure.
– Different industries may have different typical gearing ratios, and optimal levels depend on factors such as business risk and economic conditions.

5. **Interest Coverage Ratio:**
– Gearing is often analyzed alongside the interest coverage ratio, which measures the company’s ability to cover its interest expenses with its earnings.

6. **Industry Comparisons:**
– Comparing the gearing ratio of a company with industry peers provides context for understanding its financial structure.

### Example:

Suppose a company has total debt of $40 million and shareholders’ equity of $60 million. The gearing ratio would be calculated as follows:

\[ \text{Gearing Ratio} = \left( \frac{40}{40 + 60} \right) \times 100 = \left( \frac{40}{100} \right) \times 100 = 40\% \]

In this example, the gearing ratio is 40%, indicating that 40% of the company’s capital is funded through debt.

Gearing is an important financial metric, and companies often aim to maintain a balance that aligns with their risk tolerance, growth objectives, and prevailing economic conditions.