Gearing

Formal

Companies raise both Equity (Share Capital) and Loans (interest bearing) in the normal course of their business. This term describes the balance and blend of these two very different forms of funding. Loans are interest bearing and this interest must be paid irrespective of the profits of a company. Share Capital has ownership rights - meaning entitlement to a share in the profits, which can only be distributed when profits are made. Too many loans - high gearing, high risk. Too much equity and the right to use cheaper (lower rate) interest loans is lost.

Real-world Example

A company has $4M in debt and $2M in equity - a gearing ratio of 200%, meaning it relies heavily on borrowed money relative to its own capital, which increases financial risk if profits fall.