Gearing ratio: definition, formula and how to use it
Learn how the gearing ratio shows your debt risk and funding capacity. Use it to plan growth and talk to lenders.
Written by Shaun Quarton—Accounting & Finance Content Writer and Growth Marketer. Read Shaun's full bio
Published Friday 13 February 2026
Table of contents
Key takeaways
- Calculate your gearing ratio using the formula (Total Debt / Total Equity) × 100 to understand how much your business relies on borrowed money versus owner investment.
- Aim for a gearing ratio between 25% and 50% for most small businesses, as this represents a balanced approach that supports growth while maintaining financial stability.
- Review your gearing ratio quarterly and before major financial decisions like loan applications, as lenders typically prefer ratios in the 25-50% range when assessing creditworthiness.
- Manage your ratio by either reducing high-interest debt first or increasing equity through retained earnings and new investment, depending on your business goals and growth stage.
Gearing ratio definition
A gearing ratio is a financial metric that compares a business's debt to its equity. It shows how reliant your company is on borrowed funds relative to its intrinsic worth, giving you insight into your financial health.
Two key terms help explain gearing:
- Debt: Borrowed money, such as loans and lines of credit, that must be repaid with interest
- Equity: The owner's investment in the business, including retained earnings and share capital
Here's more about debt and equity.
Lenders, investors, and stakeholders use gearing ratios to assess financial stability. The numbers indicate:
- Higher ratio: signals greater reliance on debt, which increases financial risk but offers potential for higher returns
- Lower ratio: suggests a stronger equity position, reducing risk but potentially limiting growth opportunities
Why does your gearing ratio matter?
Your gearing ratio is a key indicator of your business's financial health. Tracking and managing it helps you make smarter financial decisions and plan for sustainable growth.
Understanding your ratio helps you:
- Make borrowing decisions: judge whether you can take on more debt without straining cash flow or increasing financial risk
- Attract investors and lenders: signal financial stability, making your business more appealing to potential funders
- Plan strategically: align your debt-to-equity structure with growth goals, whether aiming for rapid expansion or steady, low-risk growth
- Stabilise cash flow: free up more cash for reinvestment with a lower ratio, or understand why more funds go towards debt repayments with a higher ratio
- Manage risk: spot financial vulnerabilities early and take corrective action through regular reviews
Types of gearing ratios
Several gearing ratios help measure financial leverage and risk. Each looks at different aspects of your business's financial stability.
- Debt-to-equity ratio: compares total debt to total equity, showing how much of the business is funded by creditors versus owners
- Debt-to-capital ratio: measures the proportion of total capital (debt + equity) funded by debt, with higher ratios suggesting greater reliance on borrowing
- Equity ratio: represents the share of total assets financed by equity, with higher ratios indicating stronger financial stability
- Times Interest Earned (TIE) ratio: Assesses your ability to cover interest payments with pre-tax earnings. According to the Association of Chartered Certified Accountants (ACCA), a ratio above three is generally considered to be safe, reassuring lenders you can meet debt obligations.
Debt to equity ratio versus gearing ratio
The debt-to-equity ratio and gearing ratio are often used interchangeably, but they serve slightly different purposes.
- Debt-to-equity ratio: compares long-term debt to shareholders' equity
- Gearing ratio: uses various formulas that consider different types of debt relative to capital structure
Both ratios help evaluate financial risk. Use the debt-to-equity ratio for quick financial assessments and standardised comparisons. Use the gearing ratio for deeper analysis and long-term planning.
How to calculate the gearing ratio
The most common gearing ratio formula is: Gearing ratio = (Total Debt / Total Equity) × 100. Here's how to calculate it step by step.
- Calculate total debt: include all financial liabilities, such as loans, bonds, and credit lines
- Determine total equity: add retained earnings and share capital to find the owner's total investment in the business
- Apply a gearing ratio formula: For debt-to-equity, use Gearing ratio = (Total Debt / Total Equity) × 100. For debt-to-capital, use Gearing ratio = (Total Debt / (Total Debt + Total Equity)) × 100.
- Interpret the result: A higher percentage indicates greater reliance on debt, while a lower percentage shows a stronger equity position.
Example gearing ratio calculations
These examples show how to calculate a gearing ratio.
Example 1: Debt-to-equity calculation
- Total debt: £50,000
- Total equity: £100,000
Gearing ratio = (Total Debt / Total Equity) × 100
Gearing ratio = (£50,000 / £100,000) × 100 = 50%
A 50% ratio means the business has £1 of debt for every £2 of equity, representing moderate gearing.
Example 2: Debt-to-capital calculation
Gearing Ratio = (Total Debt / (Total Debt + Total Equity)) × 100
Gearing Ratio = (£50,000 / (£50,000 + £100,000)) × 100 = (£50,000 / £150,000) × 100 = 33.3%
A 33.3% ratio means debt makes up about one-third of the business's total capital.
Gearing ratio analysis
A good gearing ratio typically falls between 25% and 50% for most small businesses. Different levels indicate:
- Low gearing (below 25%): suggests a strong equity position with lower risk, but may indicate missed growth opportunities
- Moderate gearing (25% to 50%): represents a balanced approach, using debt to support growth while maintaining stability
- High gearing (above 50%): indicates heavier reliance on debt with increased financial risk, which can be acceptable in capital-intensive industries but concerning when debt exceeds equity
Typical ratios vary by industry, growth stage, and risk tolerance. Many small and medium businesses maintain a 30% to 50% debt mix, balancing borrowed funds for growth with equity for stability.
See real-world gearing ratio benchmarks from Industry Watch.
High versus low gearing: what's the difference?
High and low gearing reflect how you balance debt and equity to fund your business.
High gearing means relying more on debt than equity. A retail store taking out a large loan to buy inventory and renovate its premises would have a high gearing ratio. This approach supports growth when sales are strong, but becomes risky if revenues drop or interest rates rise.
High gearing can work if your business has stable cash flow to service debt, or if you're in a high-growth industry where you need to borrow to expand quickly.
Low gearing means using more equity and less debt. A family-owned cafe expanding by using saved profits may grow more slowly than if they'd borrowed, but they'd keep financial risk to a minimum.
Low gearing is the safer choice. By relying on equity and minimising debt, you're prioritising long-term security and financial stability. Low debt protects your credit rating, too.
Finding the right balance helps you manage financial risk while staying ready to grow.
How to manage your gearing ratio
Once you understand your gearing ratio, you might want to adjust it to support your business goals. You can adjust your gearing ratio by reducing debt or increasing equity.
Reduce your debt
- Pay down high-interest loans first to lower total debt faster
- Refinance existing loans to secure lower interest rates
- Avoid taking on new debt until your ratio improves
Another way to improve your gearing ratio is to increase equity.
Increase your equity
Consider these approaches to increase equity:
- Retain more earnings instead of taking distributions
- Bring in new investors or partners
- Issue new shares if you're a limited company
Your ideal gearing ratio depends on your business stage and goals. A startup might accept higher gearing to fund rapid growth, while an established business might prioritise lower gearing for stability.
When planning changes, think about:
- Cash flow implications of reducing debt
- How changes affect your ability to borrow in future
- Current market conditions and interest rate environment
Work with your accountant to develop a gearing strategy that fits your business. They can help you model different scenarios and track progress over time.
Keep your business finances healthy
Understanding your gearing ratio helps you decide about borrowing, growth, and risk. Whether you're preparing for a loan application or planning your next expansion, knowing where you stand financially helps you plan ahead.
Xero's cloud-based accounting software helps you track key financial metrics and generate real-time reports. With automated calculations and clear dashboards, you can monitor your debt-to-equity balance without manual spreadsheets.
Get one month free and try Xero for your business finances.
FAQs on gearing ratio
Here are answers to common questions about gearing ratios and how they affect your business.
How often should I review my gearing ratio?
Review your gearing ratio quarterly or whenever you're making major financial decisions, such as applying for a loan or planning significant investments.
Is there an ideal minimum gearing ratio?
Yes. A very low ratio might mean you're missing growth opportunities by not using available debt financing. Some debt can help accelerate expansion when managed well.
How does my gearing ratio affect my ability to get a loan?
A ratio between 25% and 50% typically signals a healthy balance to most lenders, while ratios above 50% may require stronger justification for borrowing.
What if my gearing ratio is different from industry averages?
Industry context matters. Capital-intensive sectors like construction often have higher acceptable ratios than service businesses. Compare your ratio to similar businesses in your sector rather than general benchmarks.
Does gearing ratio matter if I'm a service business with few assets?
Yes, though it may be less critical than for asset-heavy businesses. Service businesses typically have lower gearing ratios, but tracking yours still helps you understand your financial risk and borrowing capacity.
Start using Xero for free
Access Xero features for 30 days, then decide which plan best suits your business.