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It is said the higher the gearing or leverage the greater the % of borrowing. This risk , does it differ from sector to sector. If you were a loan officer in a bank what would your criteria for granting the loan . Or there is any other criteria?
Leverage refers to the amount of funds that are borrowed by a business, which are directed towards investments with the aim of obtaining a high return.= (short term debts+ long term debts)/total shareholders equity
Gearing is the measurement of the level of long term debt alongside the amount of equity held within a firm. Higher the levels of debt utilized, higher the gearing of the firm. Gearing is measured by the use of a ‘gearing ratio’, which is calculated by dividing the total debt by total equity.
Gearing focuses on the capital structure of the business – that means the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders).
The gearing ratio is also concerned with liquidity. However, it focuses on the long-term financial stability of a business. Gearing (otherwise known as "leverage") measures the proportion of assets invested in a business that are financed by long-term borrowing.
In theory, the higher the level of borrowing (gearing) the higher are the risks to a business, since the payment of interest and repayment of debts are not "optional" in the same way as dividends. However, gearing can be a financially sound part of a business's capital structure particularly if the business has strong, predictable cash flows.
