gearing ratio

Ratio of a company's permanent loan capital (preference shares and long-term loans) to its equity (ordinary shares plus reserves).

If the gearing ratio is above 100%, then the company is considered to be highly geared (having more long-term debt than equity). This means that if the company goes through bad trading conditions, because the economy goes into recession for example, it will face more difficulties than a company with a lower gearing ratio. This is because the company with the higher gearing ratio will have to carry on paying interest on its loans whereas a company with a lower gearing but the same amount of loans plus equity can cut the dividends paid to shareholders.