A gearing ratio is a category of financial ratios that compare company debt relative lớn financial metrics such as total equity or assets. Investors, lenders, và analysts sometimes use these types of ratios lớn assess how a company structures itself và the amount of risk involved with its chosen capital structure.
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What Is a Gearing Ratio?
A gearing ratio is a measurement of a company’s financial leverage, or the amount of business funding that comes from borrowed methods (lenders) versus company owners (shareholders). Well-known gearing ratios include debt-lớn-equity, debt-lớn-capital và debt-service ratios.
Although financial leverage và financial risk are not the same, they are interrelated. Measuring the degree lớn which a company uses financial leverage is a way lớn assess its financial risk.
Lenders may use gearing ratios lớn decide whether or not lớn extend credit, và investors may use them lớn determine whether or not lớn invest in a business. A higher gearing ratio usually indicates higher financial risk.
While there is no set gearing ratio that indicates a good or bad structured company, general guidelines suggest that between 25% và 50% is best unless the company needs more debt lớn operate.
How Do You Calculate a Gearing Ratio?
There are many types of gearing ratios, but a common one lớn use is the debt-lớn-equity ratio. Lớn calculate it, you add up the long-term và short-term debt và divide it by the shareholder equity. If you don’t have any shareholders, then you (the owner) are the only shareholder, và the equity in this equation is yours.
Long-term debt includes loans, leases, or any other form of debt that requires payments at least a year out. Short-term debt usually requires payment within a year.
How Gearing Ratios Work
If your company had $100,000 in debt, và your balance sheet showed $75,000 of shareholders’ or owners’ equity, then your gearing ratio would be about 133%, which is generally considered high.
Raising capital by continuing lớn offer more shares would help decrease your gearing ratio. For example, if you managed lớn raise $50,000 by offering shares, your equity would increase lớn $125,000, và your gearing ratio would decrease lớn 80%.
Another method lớn decrease your gearing ratio is lớn increase your sales in an attempt lớn increase revenue. You could also try lớn convince your lenders lớn chuyển đổi your debt into shares.
Limitations of Gearing Ratios
The results of gearing ratio analysis can add value lớn a company’s financial planning when compared over time. But as a one-time calculation, gearing ratios may not provide any real meaning.
It’s also important lớn remember that although high gearing ratio results indicate high financial leverage, they don’t always mean that a company is in financial distress. While firms with higher gearing ratios generally carry more risk, regulated entities such as utility companies commonly operate with higher debt levels.
Monopolistic companies often also have a higher gearing ratio because their financial risk is mitigated by their strong industry position. Additionally, capital-intensive industries, such as manufacturing, typically finance expensive equipment with debt, which leads lớn higher gearing ratios.
For this reason, it’s important lớn consider the industry that the company is operating in when analyzing it’s gearing ratio, because different industries have different standards.
A gearing ratio compares the funds a company borrows relative lớn its equity, or capital.Different types of gearing ratios exist, but a common one is the debt-lớn-equity ratio.A higher gearing ratio usually indicates higher financial risk lớn stockholders và lenders.It’s important lớn consider the industry và type of company when analyzing và comparing gearing ratios.
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