What is the Difference Between Gearing and Leverage?
🆚 Go to Comparative Table 🆚Gearing and leverage are terms associated with the utilization of debt for the purpose of financing a business. They are often used interchangeably, but there are subtle differences between the two concepts:
- Leverage refers to the amount of funds borrowed by a business and directed towards investments, with the goal of obtaining a higher return. It is a general term that describes the use of debt to magnify both gains and losses, depending on whether the funds are invested wisely.
- Gearing is the measurement of the level of debt alongside the amount of equity held within a firm. It is a specific type of leverage analysis that incorporates the owner's equity and is often expressed as a ratio in financial analysis. Gearing ratios are used to separate financially healthy companies from troubled ones.
The main similarity between leverage and gearing is that the gearing ratio is derived from evaluating the levels of debt within the firm. Both concepts involve the use of debt to finance a business's operations and investments, but gearing specifically measures the relationship between debt and equity.
Some key points to remember are:
- Leverage refers to the use of debt for investing and obtaining a higher return.
- Gearing is a specific type of leverage analysis that incorporates the owner's equity, often expressed as a ratio in financial analysis.
- Europeans tend to use the term "gearing" (especially in British English/finance), while Americans refer to it as "leverage".
Comparative Table: Gearing vs Leverage
Gearing and leverage are financial ratios that measure a company's financial risk by indicating how much of its operations are financed through debt. While they are similar in some ways, they differ in how they measure a company's financial leverage. Here is a table comparing the differences between gearing and leverage:
| Gearing | Leverage |
|---|---|
| Gearing is a measurement of a company's financial leverage, indicating the degree to which a firm's operations are funded by shareholders' funds versus debt. | Leverage is a financial ratio that measures a company's debt level relative to its assets. |
| Gearing ratios are financial ratios that compare some form of owner's equity (or capital) to debt, or funds borrowed by the company. | The leverage ratio, also known as the gearing ratio, is a financial analysis tool used to determine the extent of debt in a company's capital structure. |
| The most common type of gearing ratio is the net gearing ratio, which is calculated by dividing the total debt by the shareholder equity. | One of the most commonly used leverage ratios is the gearing ratio, which shows the extent to which a company's operations are financed by long-term debt. |
| A high gearing ratio typically indicates a high degree of leverage, which can be seen as a riskier financing structure. | A high leverage ratio indicates that a company has a higher degree of financial risk. |
In summary, gearing and leverage are both financial ratios that measure a company's financial risk, but they differ in how they measure the company's financial leverage. Gearing focuses on the proportion of debt to equity, while leverage measures the company's debt level relative to its assets.
- Operating Leverage vs Financial Leverage
- Negative vs Positive Gearing
- Debt vs Equity
- Finance vs Leasing
- Debt Ratio vs Debt to Equity Ratio
- Equity vs Debt Financing
- Lending vs Borrowing
- Lending Rate vs Borrowing Rate
- Levered vs Unlevered Free Cash Flow
- Liability vs Equity
- Loan vs Lease
- Loan vs Debt
- Loan vs Borrow
- Equity vs Capital
- Derivatives vs Equity
- Equity vs Debt Securities
- Cost of Equity vs Cost of Debt
- Liquidity vs Solvency
- Cost of Capital vs Cost of Equity