Gearing Ratios: Trading Company vs Bank

[Snoopy]

The 'Gearing Ratio' is one of the simplest statistics to assess the underlying risk of a company you wish to invest in. An internet search for a definition of Gearing Ratio brings up ideas where 'long term debt' is compared to 'shareholders equity'. I prefer to use the term 'bank negotiated debt'. This is becauue long term agreements with a bank often have a portion of that debt maturing in the current period. It seems wrong to ignore the current portion of that bank debt, even if it is not strictly 'long term'.

All companies have company assets that are funded by a mixture of owners equity and debt. I have graphically represented this in my typical 'trading company' below:

Trading Company
Debt	D
	B
Equity	A
Assets	A+(B+D)

In the table:

'B' represents the negotiated bank debt
'D' represents other debt, for example wages owed to employees and bills as yet unpaid to suppliers.
'A' represents the shareholders equity in the company.

Our particular company has no other positive equity apart from 'A'. This would be unusual. But complicating the model by bringing other kinds of assets into our model company would only serve to obfuscate the discussion.

The 'Gearing Ratio' for our Trading company is calculated very simply:

Gearing Ratio = B/A

The higher the 'Gearing Ratio', in general, the more risky is the company.

SNOOPY