Gearing measures how much of a business is financed by debt rather than by its owners. The two usual versions are debt divided by equity, and debt divided by debt plus equity; there is no legal limit, but a common view is that gearing is high once debt exceeds equity, which is a debt to equity ratio above 100% or a debt to capital ratio above 50%.

What does the gearing ratio measure?

ACCA’s ratio analysis guidance describes gearing as relating to an organisation’s relative levels of debt and equity, helping to measure its ability to meet long term debts. The ratios are also called leverage, risk, positioning or solvency ratios. The point is risk: interest and capital repayments are legal obligations that must be met to avoid insolvency, whereas a dividend on ordinary shares is not.

Gearing also cuts the other way. ACCA notes that lenders accept a lower return than shareholders because they are better secured, and that interest, unlike dividends, is deductible for tax. A business that borrows to fund profitable work can earn a higher return on its equity than it could from equity alone. Gearing magnifies both good and bad years.

How is gearing calculated?

ACCA says many definitions exist and gives the two most common:

  • Debt to equity = non current liabilities ÷ ordinary shareholders’ funds × 100%
  • Debt to debt plus equity = non current liabilities ÷ (ordinary shareholders’ funds + non current liabilities) × 100%

ACCA’s financial statements interpretation article uses debt ÷ equity, or debt ÷ (debt + total equity). In practice “debt” is usually defined more precisely than all non current liabilities, because provisions and deferred tax are not borrowings. Common definitions of debt include:

  • bank loans, both the current and non current parts
  • overdrafts that are used as permanent funding
  • hire purchase and lease liabilities
  • loans from directors and shareholders, unless formally subordinated
  • preference shares classified as liabilities

A net debt version deducts cash. FRS 102 defines net debt as the borrowings of an entity, together with any related derivatives and obligations under leases, less cash and cash equivalents, and paragraph 7.22 requires entities that prepare a cash flow statement to reconcile the movement in net debt. Small entities are exempt from Section 7 under paragraph 7.1B, so many small company accounts will not show this analysis. Net debt to equity is fairer to a business holding large cash balances, but less cautious if that cash is needed for working capital.

What does a worked example look like?

Illustration only. A company’s balance sheet shows:

Item £
Bank loan (all instalments) 400,000
Lease liabilities 100,000
Cash at bank 150,000
Share capital and reserves 600,000
Operating profit 180,000
Interest payable 40,000
  • Debt = 400,000 + 100,000 = £500,000.
  • Debt to equity = 500,000 ÷ 600,000 = 83%.
  • Debt to debt plus equity = 500,000 ÷ 1,100,000 = 45%.
  • Net debt to equity = (500,000 less 150,000) ÷ 600,000 = 58%.
  • Interest cover = 180,000 ÷ 40,000 = 4.5 times.

The same balance sheet produces three gearing figures between 45% and 83%. None is wrong, so any comparison, target or covenant has to state which definition it uses.

What level of gearing is considered high?

There is no statutory or accounting standard threshold. ACCA’s guidance says levels of gearing vary enormously between industries, that businesses needing heavy investment in tangible assets are commonly highly geared, and that it is therefore difficult to generalise. It adds that most accountants would agree gearing is too high when the proportion of debt exceeds the proportion of equity. On the two common measures that means:

  • debt to equity above 100%
  • debt to debt plus equity above 50%

ACCA’s financial statements interpretation article makes the counterpoint: high gearing need not cause concern if the business has strong security in tangible assets and comfortably covers its interest. That is why gearing is read with interest cover, operating profit divided by finance costs. ACCA’s ratio analysis article says interest cover above three is usually considered safe.

A property investment company with long leases and secure rent can sustain gearing that would be dangerous for a contractor with volatile profits and few assets. Compare against the business’s own history and its sector, and look at when the debt is repayable.

What can change gearing without any new borrowing?

  • Losses and dividends. Both reduce equity, so gearing rises even if debt is unchanged.
  • Revaluations. Revaluing property increases equity through the revaluation reserve and reduces gearing.
  • Preference shares. FRS 102 paragraph 22.5(e) classifies a preference share as a financial liability if it must be redeemed for a fixed or determinable amount at a fixed or determinable date, or the holder can require redemption. Paragraph 22.5(c) treats an instrument as a liability if it obliges payments before liquidation, such as a mandatory dividend. Such shares count as debt, not equity; see debt or equity preference shares.
  • Lease accounting. Amendments in the September 2024 edition of FRS 102 apply for accounting periods beginning on or after 1 January 2026. Under paragraph 20.45 a lessee recognises a right of use asset and a lease liability at the start of a lease, subject to the optional exemptions in paragraph 20.5 for short term leases and low value assets. Businesses with significant property or equipment leases will see reported debt and gearing rise with no change to their actual commitments. The FRS 102 2026 amendments page covers the change.

Does tax affect how a business should be geared?

Interest is generally deductible, which is part of why debt is cheaper than equity. For larger groups there are limits. HMRC’s Corporate Finance Manual at CFM95110 explains that the Corporate Interest Restriction restricts a group’s deductions for interest and other financing costs, but that groups with less than £2 million of net interest expense a year will not suffer any restriction; see corporate interest restriction.

Separately, HMRC’s International Manual at INTM511015 explains thin capitalisation: a UK company is thinly capitalised when it has more debt than it could or would borrow on its own without group support, which can arise where it borrows from connected companies or from third parties on the strength of group guarantees. In those cases the arm’s length principle can deny interest on the excess. Most owner managed companies borrowing from their bank are not affected, but shareholder and group loans should be priced and sized with this in mind.

What mistakes come up most often?

  • Comparing gearing figures calculated on different definitions.
  • Leaving the current portion of loans, or a permanent overdraft, out of debt.
  • Counting redeemable preference shares as equity when FRS 102 treats them as liabilities.
  • Forgetting that new lease liabilities under the 2026 FRS 102 changes will increase debt.
  • Reading gearing without interest cover, repayment dates or the security behind the debt.

Gearing is one of the ratios worth tracking in management accounts, especially where a lender tests it as a covenant.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.