Gearing

Gearing is the balance-sheet measure of leverage, classically calculated as net or gross financial debt divided by equity. A gearing of 1.5 means that every euro of equity carries 1.50 euros of interest-bearing debt. It is therefore the narrow, directly observable balance-sheet version of the broader concept of leverage, which also covers operating leverage from the fixed-cost base and the leverage effect on return on equity. Defining both inputs matters: whether pension obligations, lease liabilities and shareholder loans count as financial debt, and whether equity is adjusted for minority interests or for goodwill, changes the result considerably.

In transactions it is used less often than debt/EBITDA, because the latter measures debt capacity against earnings rather than against an equity figure that accounting choices and goodwill can distort. This is especially clear after a leveraged buyout, where a high purchase price can produce substantial goodwill. Goodwill does not itself create additional equity. Deducting it from book equity for credit analysis produces a correspondingly higher gearing ratio. Conversely a company whose fixed assets are carried at low historical values can show very high gearing without being financially stretched. Gearing is most informative within a sector comparison and over time for the same company.

It should be noted that the ratio becomes arithmetically useless where equity is negative, which can occur after a heavily leveraged buyout or after loss-making years. In such cases only earnings-based measures remain. It should also be borne in mind that the ratio can improve purely through a revaluation of assets or a capital increase, without any change in the ability to service debt. Meaning therefore emerges only from several metrics considered together.