Which statement best defines the gearing ratio?

Which statement best defines the gearing ratio?

• A. It is defined as debt divided by equity.
• B. It is defined as debt divided by assets.
• C. It is defined as equity divided by assets.
• D. It is defined as total financing divided by equity.

Answer: (A)

Gearing ratio measures a company’s financial leverage by comparing the amount of debt to the amount of equity available to shareholders. It answers the question: how much debt is used for each dollar of equity? The standard definition is debt divided by equity, which is why this statement is the best fit. A higher gearing ratio means more reliance on debt, signaling greater financial risk if earnings weaken or debt costs rise. By comparison, debt divided by assets would show how much of the firm’s assets are funded by debt (the debt ratio), not the balance between debt and equity. Equity divided by assets is the equity ratio, indicating how much of the asset base is funded by equity. Total financing divided by equity would mix debt and equity into a single measure that isn’t the conventional gearing concept.

Gearing ratio measures a company’s financial leverage by comparing the amount of debt to the amount of equity available to shareholders. It answers the question: how much debt is used for each dollar of equity? The standard definition is debt divided by equity, which is why this statement is the best fit. A higher gearing ratio means more reliance on debt, signaling greater financial risk if earnings weaken or debt costs rise.

By comparison, debt divided by assets would show how much of the firm’s assets are funded by debt (the debt ratio), not the balance between debt and equity. Equity divided by assets is the equity ratio, indicating how much of the asset base is funded by equity. Total financing divided by equity would mix debt and equity into a single measure that isn’t the conventional gearing concept.