Financial gearing
Common measures are debt/equity and debt/(debt + equity), using book or market values as specified. State the convention before comparing figures. Borrowing creates contractual payments that have priority over ordinary shareholders, so changes in operating performance can produce larger proportional changes in equity earnings. Gearing can bring interest tax benefits but also raises financial distress and refinancing exposure. It is different from operating gearing, which concerns the effect of fixed operating costs. High gearing is not automatically good or bad; assess cash generation, stability, terms and risk.
Worked example
Debt is $30 million and equity $70 million. Debt/equity is 42.86%, whereas debt/total capital is 30%. Both describe the same structure using different denominators. Comparing 42.86% with another firm's debt/total percentage would be misleading.
Common mistake
Comparing gearing ratios without checking both the denominator and whether market or book values were used.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Supporting | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |