Define what is meant by gearing

According to Adrian and Shin (2008), the gearing namely the debt equity ratio was often used by many business investors as a fast measure to analyze the amount of capital invested by these shareholders of the company in the history. And this kind of ratio is also used as a tool for a company to explain the relationship between the debt and equity used in its finance when it operates the business in the present time.

And Adrian and Shin (2008) also point out that as the most common type of gearing ratio, debt equity ratio owns three variations as well. It equals long term debt divide equity and it also equals total debt divide equity as well as net debt divide equity. At the same time, the business creditors and investors also have a close look at the debt equity ratio due to this ratio facilitate the revealment the dimension of the management in a company prefers to fund its business operation with debt instead of using equity. Besides the above players, lenders especially the banks are required to be sensitive enough towards the gearing namely the debt equity ratio, because if this ratios remains high it may imply that the loans issued by them may be at a risk of no payment. In the field of company, this ratio is also so important. It is important for a firm to get a clear view on what is the short term debt in the technical field but it may become a long term debt as well. For example, an overdraft is payable if there is a demand but it may also not pay off for a long time if there is no demand. And under such situation, it is necessary for a company to use the gearing to get the relationship between total debt and equity to facilitate the business operation (Hovakimian & Opler 2001).

As the debt equity ratio is paid great attention by so many groups, let take a closer look at its real meaning. And the debt equity ratio is less than one, or higher than one may have different meaning which may also require the business players to take different actions towards the different situation. According to Masulis (1988), if the calculation result of the debt equity ratio is less than one namely having a comparative low financial gearing, the total amount of the equity of this company is more than the total debt, which indicates the company may act more flexibly to manage its debt with the support of sufficient equity. And if the calculation result of the debt equity ratio equals one, it may told us the amount of the capital may equals the amount of the borrowing, which may require the company to take a good consideration when manage its business operation finically. Moreover, if the result is more than one, it may imply that the total debt amount is larger than the amount of the equity which may be at a risk for both the business and lenders or investors to gain the money back.

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