Interest cover: what it means for business borrowing
Interest cover is how many times a business's profit covers the interest on its borrowing: operating profit (or EBITDA) divided…
Business loans
Gearing ratio: what it means for business borrowing
Gearing ratio meaning: how much of a business is funded by debt rather than equity. The formulas, a UK example, high vs low gearing and how lenders read it.
In this guide
Gearing is the balance between borrowed money and the owners' money (equity) in a business. The gearing ratio puts a number on it, and lenders use it to judge how much more debt a business can safely carry.
The formulas
- Debt to equity: total borrowing ÷ shareholders' funds × 100.
- Debt to capital: total borrowing ÷ (borrowing + shareholders' funds) × 100.
- Net gearing: uses borrowing less cash held.
Borrowing usually includes loans, overdrafts, hire purchase and lease liabilities. Make sure you compare like with like, because lenders and analysts define it differently. Leverage, used in larger deals, is debt divided by EBITDA.
An example
A wholesaler has £600,000 of loans and hire purchase and shareholders' funds of £400,000. Debt to equity is 150%; debt to capital is 60%. If it borrowed another £200,000 without adding equity, debt to equity would rise to 200%.
High and low gearing
| Low gearing | High gearing | |
|---|---|---|
| Risk to lenders | Lower | Higher: more of the profit goes on interest |
| Effect of rising rates | Small | Larger, especially on variable-rate debt |
| Return to owners in good years | Lower | Higher |
Where lenders find the figures
Lenders take gearing from your latest filed or management accounts. Director loans can count as debt or, if the directors agree to leave them in the business (a postponement), be treated more like equity. Leases and hire purchase now sit on many balance sheets as liabilities, which raises reported gearing without any new borrowing.
£212,300A transaction we arrangedApproved, then nearly lost at completion. £212K consolidated.A property-title requirement threatened a consolidation deal at the last hurdle. We worked it through and kept the structure intact.How gearing affects borrowing
Lenders look at gearing alongside interest cover and cash flow. A highly geared balance sheet does not rule out new borrowing, but lenders may want security, a lower amount or a plan to reduce debt. Refinancing expensive short-term debt into one longer loan can improve cash flow without changing gearing much. See refinancing business loans and business debt consolidation. Any broker fee depends on the lender, with nothing to pay upfront.
Related terms
Sources
This guide is general information, not financial advice. Lenders set their own criteria, rates and terms, and all finance is subject to status.
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FAQs
Common questions
What is a good gearing ratio?
It depends on the sector and how stable the profits are. Property and asset-heavy businesses often carry more debt than service firms. Lenders look at gearing together with interest cover and cash flow, not on its own.
How can a business reduce its gearing?
Retain profits, raise equity, repay debt or sell surplus assets. Converting director loans into share capital also lowers gearing on paper, which lenders may take into account.
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