← Business Metric: Financial (all topics)
Debt to equity & gearing
What it is
Total borrowings divided by shareholders' funds - how much of the balance sheet is funded by lenders rather than owners. It is the classic solvency measure and the most common loan covenant after net debt to EBITDA
Unlike coverage ratios it tests the stock of debt rather than the ability to service it
Impact on industries
- Directly measures financial risk and the cushion available to absorb losses before lenders are impaired
- Low gearing preserves the option to borrow when opportunities appear, which is itself worth something in a cyclical business
- Equity is a book figure, so an old or written-down asset base distorts the ratio in both directions
- Optimal gearing varies enormously by sector - a utility with contracted cash flows can carry debt that would sink a commodity producer