Capital Gearing

Capital gearing is a British term that refers to the amount of debt a company has relative to its equity. In the United States, capital gearing is known as known as "financial leverage." Companies with high capital gearing will have a large amount of debt relative to their equity. The gearing ratio is a measure of financial risk and expresses the amount of a company's debt in terms of its equity. A company with a gearing ratio of 2.0 would have twice as much debt as equity.

Capital gearing will differ between companies and industries. In industries requiring large capital investments, gearing ratios will be high. Lenders and investors pay close attention to the gearing ratio because a high ratio suggests that a company may not be able to meet its debt obligations if its business slows down. Companies that are in cyclical industries and have high gearing ratios may, therefore, be viewed by investors as risky. In stable industries, however, a high gearing ratio may not present a concern. Utility companies, for example, require large capital investments, but they are monopolies and their rates are highly regulated. So, their revenues and income are highly stable.

Companies may at times increase their use of gearing. In the event of a leveraged buyout, the amount of capital gearing a company will employ will increase dramatically as the company takes on debt to finance the acquisition.