Definition of gearing ratio
Gearing ratio is the ratio used in measuring leverage which of course has an influence on the company’s finances and the level of useful liabilities in its capital structure, this Apostle is calculated by dividing the total debt owned by the company by shareholder equity. In addition, it can also be done by calculating the total debt divided by the total capital.
In practice in the field, we find that interest expense can be deducted from taxes, some companies can also increase their profits and profits on equity, usually by increasing the proportion of debt in their capital structure, but we also have to be careful because an increase in the level of debt can also have an impact. directly increase the risk of loss to the company.
Some companies that want to apply for a loan extension to an investor who provides the loan can use this ratio calculation and they will definitely decide to invest their funds in the business or not. The higher this ratio indicates that the higher the financial risk that the investor may have to face.
How to calculate gearing ratio
Some of the gearing ratio theories are quite a lot but the one that is very widely used by economic actors is the ratio of debt to company equity, before we calculate it we must know that we can add between long-term debt and short-term debt after that we can divide it by shareholder equity will but if we don’t have shareholders then we can include that the business owner is also counted as one of the shareholders in the company and equity, some components that enter into long-term debt are usually classified as lease loans or other forms of debt whose repayment period is not counted. more than 1 year, if more than 1 year period and the payment is included in long-term debt.
This ratio can be lower if we increase the amount of capital by offering more shares and can also be done by increasing sales so that our company’s income figures increase. We can also do this by working with lenders to convert the debt into shares.
The gearing ratio with a score higher than 50% can be classified as high leverage, in this case the company is at greater financial risk where the profits generated by the company are low and the interest rates tend to be high, which can cause the company to be vulnerable to default. The loan usually suffers a loss.
If the gearing ratio is lower than 25%, this means the company is in a low-risk condition so that it becomes the interest of investors and lenders.
But sometimes we know that the ratio is at 25% to 50% this means that the company is in optimal or normal conditions, companies that have good performance are in this ratio.
We can see for each type of gearing ratio, it turns out that the value is different, and its use will depend on our own goals. For example, from the debt to capital ratio we can conclude that 44% of the company’s capital comes from debt. Furthermore, on the debt to equity ratio, we can conclude that the value of 0.8 means that the value of debt is smaller than equity because the value is less than 1. Meanwhile, if we look at the value of the debt to assets ratio, where the value is 1.6, it means that the value of the company’s debt is greater than the company’s assets of 1.6 times. So, which one to use will depend on our goals.
Each gearing ratio will have a different interpretation. Even if we talk about standardization, there is no standard value that can conclude whether a company’s gearing ratio is good or not. For example, a company that has a large debt to equity ratio sometimes doesn’t matter if the company’s cash flow is high enough, because high cash flow means that the company’s profits are also high and that cash flow can be relied on to pay off the company’s debt. Comparison with other companies engaged in similar business sectors can also be used as a reference. So the use of the gearing ratio is very broad, varied, and can product
In economics, that the running of an economic activity in a company, whether it includes the production process or other processes, of course requires a resource that will be able to carry out business activities within the company. Where within the company itself there are various kinds of resources that can be used so that the company’s activities can run, in general there are two sources, namely liabilities or debts and using equity or using company capital.
If a company in its business activities uses more of its capital resources, either through investors such as shares or from retained earnings owned by the company, it is likely that the gearing ratio of the company is small and vice versa if the company only prioritizes debt, whether it is caused by compulsion because of the economic crisis in the company, it is very likely that the gearing ratio owned by the company is very large, therefore we can conclude that the gearing ratio is the large percentage of the company’s finances that is used by using obligations or liabilities, how the gearing ratio is calculated by dividing between the total debt of the company with the equity held by the shareholders.
If the gearing ratio owned by the company is large, it is likely that the company has financial problems which are mainly due to the company’s inability to cover its obligations or liabilities or even because of other matters relating to the debt itself. owned by the company is small then of course this can be interpreted that the company is still able to survive and economic activities can run smoothly.
In this case, the debt calculation used in the analysis using the gearing ratio, of course, uses all types of forest that exist within the company, which includes long-term debt and short-term debt that only lasts for one accounting period. Therefore, in the calculation of the gearing ratio, we can measure by adding up the total debt, including both long-term and short-term forests and then dividing by shareholder equity.
