Gearing in One Line
A gearing ratio tells you how much of a business is funded by borrowed money compared with money that belongs to its owners.
The most common UK version is:
Gearing ratio = debt ÷ (debt + equity) × 100
If a company has £140,000 of borrowings and £150,000 of equity, its gearing is 140,000 ÷ 290,000, which is 48%. Just under half of the long-term money in the business came from lenders. The rest came from shareholders, either as share capital or as profit left in the business over the years.
A business with a lot of debt relative to equity is called highly geared. One with little or no debt is low geared. In the US the same idea is called leverage, and you will see the words used interchangeably.
That is the definition. The problem is that "gearing ratio" is not one formula. It is a family of them, and people quote the result without saying which one they used.
Where the Numbers Come From on a UK Balance Sheet
You need two figures, and both are on the face of any set of UK company accounts.
Equity is the bottom section of the balance sheet, headed "capital and reserves". It is share capital plus retained earnings plus any other reserves. It always equals net assets, because of the accounting equation.
Debt is harder, because UK accounts do not have a line called debt. Borrowings are split across two headings:
- Creditors: amounts falling due within one year. The overdraft, the next twelve months of loan and hire purchase repayments, and often a director's loan account.
- Creditors: amounts falling due after more than one year. The rest of any bank loan or hire purchase agreement.
You have to go into the notes to pull out the interest-bearing items and leave out trade creditors, VAT, PAYE and corporation tax, none of which are borrowing in the sense gearing cares about. That judgement call is the first place two people calculating the "same" ratio start to disagree.
Five Versions of the Formula
Here are the versions you will actually meet, in textbooks, bank credit papers and broker reports.
| Version | Formula | Where you see it |
|---|---|---|
| Long-term gearing | Non-current borrowings ÷ (non-current borrowings + equity) | A-level Business, some older textbooks |
| Capital gearing | Total borrowings ÷ (total borrowings + equity) | ACCA and most UK accountancy teaching |
| Net debt to equity | (Borrowings − cash) ÷ equity | Listed company reports, analysts |
| Debt to equity | Total borrowings ÷ equity | Banks, US sources, credit agencies |
| Debt to equity including director funding | (Borrowings + director's loan) ÷ equity | What an owner-managed company really looks like |
The first two give a percentage out of 100, because debt is part of the denominator. The last three can run past 100%, because they compare debt with equity directly. A "debt to equity of 100%" and a "capital gearing of 50%" describe exactly the same company.
If you are studying for an exam, use the version in your syllabus and state it. If you are running a business, pick one and stick to it, because the trend is worth far more than the number.
A Worked Example
Hartley Print Ltd is a commercial printer in Watford with a 30 June year end. Here is what matters for gearing at 30 June 2026.
| Due within one year | Due after one year | Total | |
|---|---|---|---|
| Bank term loan | £18,000 | £72,000 | £90,000 |
| Hire purchase on the litho press | £12,000 | £28,000 | £40,000 |
| Bank overdraft | £10,000 | £10,000 | |
| Borrowings | £140,000 | ||
| Director's loan account (owed to the director) | £45,000 | £45,000 |
Cash at bank is £25,000. Equity is £150,000, made up of £100 of share capital and £149,900 of retained profit.
Now run the five formulas:
| Version | Calculation | Result |
|---|---|---|
| Long-term gearing | 100,000 ÷ (100,000 + 150,000) | 40% |
| Capital gearing | 140,000 ÷ (140,000 + 150,000) | 48% |
| Net debt to equity | (140,000 − 25,000) ÷ 150,000 | 77% |
| Debt to equity | 140,000 ÷ 150,000 | 93% |
| Including director's loan | 185,000 ÷ 150,000 | 123% |
One company, one balance sheet, one day. Somewhere between 40% and 123% depending on who is holding the calculator.
This is why we are wary of any article that tells you the "ideal" gearing ratio is 25% to 50% without saying which formula it means. On the long-term version, Hartley is comfortably inside that range. On debt to equity, it is nearly double the top of it. Neither answer is wrong. They are measuring slightly different things.
What Is a Good Gearing Ratio?
The usual UK rule of thumb, applied to capital gearing, goes like this:
- Above 50%: high gearing
- 25% to 50%: normal for an established business
- Below 25%: low gearing
As a starting point that is fine. As a target it is close to useless, because what a business can safely carry depends on how steady its profits are and what its assets are worth to a lender.
A property investment company with a portfolio of let houses routinely runs mortgages at 60% to 75% of property value, and nobody sensible calls that reckless. The assets are easy to value, the rent is predictable, and the lender has a charge over bricks. A design agency with the same gearing would be in a very different position, because its main assets are its people and its debtors, and neither can be sold to repay a loan.
Our view, from the owner-managed companies we see: the question worth asking is "could the business keep paying the interest and the capital if profits fell by a third for a year?" If the answer is yes, the gearing is probably fine whatever the percentage. If the answer is no, a low percentage will not save you.
Zero gearing is also more common than the textbooks suggest. The long-running SME Finance Monitor survey has for years found that a very large share of UK small businesses describe themselves as permanent non-borrowers. For many of them a gearing ratio is simply 0%, and that is a choice, not a failing.
High Gearing vs Low Gearing
| High gearing | Low gearing | |
|---|---|---|
| Main funding source | Lenders | Owners and retained profit |
| Fixed interest cost | Large | Small or none |
| Effect of a good year | Returns to shareholders are amplified | Returns are steadier |
| Effect of a bad year | Interest still has to be paid, losses amplified | More room to absorb a dip |
| Exposure to rate rises | High, especially on variable rate debt | Low |
| Ability to borrow more | Limited | Usually good |
The amplification is the whole point of borrowing. If Hartley borrows at 7.5% and invests the money in a press that earns 20% on the capital, the extra 12.5% goes to the shareholders. Owners get a bigger return on their own money than they could have got without the loan. That works right up until the press earns less than the interest, at which point the same arithmetic runs in reverse.
This is financial gearing, and it is a different thing from operational gearing, which is about how much of a business's cost base is fixed. We cover that in fixed costs vs variable costs. A business with high fixed costs and high borrowing is geared twice over, and its profits will swing hardest of all.
Interest Cover: The Number Lenders Actually Watch
Gearing is a balance sheet ratio. It tells you how much debt there is. It does not tell you whether the business can afford it. For that you need interest cover.
Interest cover = operating profit ÷ interest payable
Hartley made an operating profit of £84,000 last year and paid £11,000 of interest across the loan, the hire purchase and the overdraft. Interest cover is 84,000 ÷ 11,000, which is 7.6 times. It could pay its interest bill more than seven times over.
Below about 2 times is where people start to worry. Below 1, the business is not earning enough to pay its interest at all.
In our experience, when a bank puts a covenant on a small company loan, it is usually a cash-based test like this, or a multiple of debt to EBITDA, rather than a straight gearing percentage. Gearing is what outsiders can calculate from your filed accounts. Interest cover is what the lender cares about once they have lent.
Five Things That Distort Gearing in a Small Company
1. The director's loan account. Hartley's director has lent the company £45,000. On paper that is a creditor repayable on demand, and on the strictest reading it is debt. In substance it is the director's own money, it is almost never going to be called in while the business needs it, and it behaves much more like equity. That single balance is the difference between 93% and 123% in the table above.
There is a tax point here too. If the company pays the director interest on that loan, the interest is deductible for corporation tax. But the company generally has to deduct 20% income tax from yearly interest paid to an individual and report it to HMRC quarterly on form CT61. We see plenty of companies paying directors interest and very few doing the CT61. If you are going to do it, do it properly.
2. Personal guarantees. The bank that lent Hartley £90,000 will almost certainly have asked the director for a personal guarantee. The company's gearing is 48%, but the risk behind the loan sits partly with the director's house. For owner-managed businesses we think the honest gearing figure is the one that includes what the owner has personally guaranteed, because that is the exposure the family is actually carrying. No balance sheet will show you that.
3. The 2026 lease changes. For accounting periods beginning on or after 1 January 2026, the amended FRS 102 puts almost every lease on the balance sheet as a liability, alongside a right-of-use asset. We explain the mechanics in finance lease vs operating lease.
Say Hartley's premises lease has five years left at £30,000 a year. Discounted at 7%, that is a lease liability of roughly £123,000. Its first year under the new rules starts on 1 July 2026. On capital gearing, the company moves from 48% to about 64% overnight. Interest cover falls from 7.6 to about 4.6, because £30,000 of rent turns into depreciation plus an interest charge of around £8,600. Nothing about the business has changed. Micro-entities using FRS 105 are not affected, but small companies preparing FRS 102 accounts are. If you have a covenant with a gearing or interest cover test in it, look at it now.
4. Negative equity. A young company funded entirely by its founder's loan often has accumulated losses bigger than its share capital, so equity is negative. The gearing ratio then produces a negative or absurd number. It is not telling you the business is safe or unsafe. It is telling you the ratio has stopped working, and you should look at the debt, the cash and the forecast directly.
5. Paying everything out as dividends. Some owners take every penny of profit as dividends, then borrow to buy the next van. Retained earnings stay low, borrowings go up, and gearing rises year after year even though the business is profitable. There can be good personal tax reasons for extracting profit, but it is worth seeing the effect on the balance sheet before the next finance application, not after.
The Tax Angle: Why Debt Got Cheaper in 2023
Interest is a deductible expense for corporation tax. Dividends are paid out of profit that has already been taxed. That asymmetry has always made debt slightly cheaper than equity for a company that pays tax.
Since April 2023 the main rate of corporation tax has been 25%, with a 19% small profits rate and marginal relief in between. Hartley's taxable profit of £73,000 sits in the marginal relief band, where the effective rate on each extra pound is 26.5%. So its £11,000 interest bill saves roughly £2,900 of corporation tax. A 7.5% loan costs Hartley about 5.5% after tax.
When the main rate was 19%, the same deduction was worth less. So the rate rise quietly made borrowing more attractive relative to equity for companies in the marginal and main rate bands. Larger groups face the corporate interest restriction, but that only bites where net interest expense is above £2 million a year, which rules out almost every business we work with.
Our view: the tax saving is real but it should never be the reason to borrow. A loan you did not need, taken for the tax relief, is still a loan you have to repay. If you are weighing up debt against putting more of your own money in, that is a tax planning conversation worth having with the numbers in front of you.
Gearing and Interest Rates in 2026
Plenty of small company borrowing is on a variable rate linked to Bank Rate. In 2021 Bank Rate was 0.1%. In September 2026 the Bank of England held it at 3.75%, with three of the nine committee members voting to raise it to 4%.
That matters because the same gearing ratio carries very different risk at different interest rates. A company with 50% gearing on a variable loan paid a fraction of the interest in 2021 that it pays now, on exactly the same balance sheet. Gearing has not moved. Interest cover has collapsed. This is why we would always look at the two together, and why a gearing figure on its own tells you less than it appears to.
Gearing vs the Current Ratio
These two are often mentioned together, and they answer different questions.
- The current ratio is about the next twelve months. Can the business pay what it owes in the short term from assets that should turn into cash in the short term?
- Gearing is about the long-term shape of the business. How much of it is funded by people who expect to be repaid with interest, regardless of how the year goes?
A business can have a healthy current ratio and dangerous gearing, for example if it has plenty of debtors but a large loan due in three years. It can also have low gearing and a current ratio below 1, like a growing company with no bank debt but a pile of supplier invoices. You need both to see the full picture. Working capital sits alongside them as the same short-term story in pounds.
Common Mistakes We See
- Including trade creditors as debt. Supplier invoices are not borrowing. Leave them, VAT and tax out.
- Leaving out the short-term part of a loan. The next twelve months of repayments sit in creditors due within one year, but they are still part of the loan.
- Comparing two gearing figures calculated differently. Check the formula before comparing yourself to a benchmark, a competitor or last year's number from a different accountant.
- Ignoring the director's loan account. Decide whether you are treating it as debt or quasi-equity, and be consistent.
- Treating low gearing as automatically good. A profitable business that refuses to borrow for a machine that would pay for itself in two years is leaving money on the table.
- Forgetting that gearing affects what a business is worth. Buyers usually value the whole business and then deduct net debt, so every pound of borrowing comes off the price the owner walks away with. We cover that in how do you value a business.
How IAK Can Help
We work with limited companies, small businesses, property developers and landlords across North London and Hertfordshire. Gearing usually comes up when a bank has asked for it, when a covenant is getting close, or when an owner is deciding whether to borrow or put more of their own money in.
The ratio itself takes a minute. The useful work is deciding which debt belongs in it, what the director's loan and personal guarantees really mean, what the 2026 lease rules will do to next year's figures, and whether the business can service what it owes if trading gets harder. That is the part a set of statutory accounts will not do for you.
If you want gearing and interest cover tracked monthly, that is what management reporting is for. If you are about to borrow, refinance or file accounts that a lender will read, get in touch, or read more about our accounting and tax planning services.
Sources
- Bank Rate maintained at 3.75%, September 2026 Monetary Policy Summary, Bank of England, for the 6 to 3 vote to hold Bank Rate at 3.75% on 16 September 2026.
- Corporation Tax rates and reliefs, GOV.UK, for the 25% main rate, the 19% small profits rate and marginal relief from 1 April 2023.
- CFM95000, Corporate Interest Restriction, HMRC Corporate Finance Manual, for the £2 million de minimis allowance for net interest expense.
- Pay tax on interest paid to individuals: CT61, GOV.UK, for the requirement to deduct and report income tax on yearly interest paid by a company.
- FRS 102 Periodic Review 2024 amendments, Financial Reporting Council, for the on-balance-sheet lease model for periods beginning on or after 1 January 2026.
- SME Finance Monitor, Ipsos, for UK data on SME use of external finance and permanent non-borrowers.