Interpret and manage gearing
Calculate Cambridge's gearing ratio, explain financial risk and assess strategies to change the balance between debt and equity.
Cambridge International AS & A Level Business 9609, 2026–2028 syllabus and 2029 syllabus, section 10.2.4. Ratio calculations use the formulae listed in the relevant Cambridge syllabus. Written practice is self-checked. Specialist review has not been completed for this lesson; these exercises do not award an official mark or establish exam readiness.
Before you begin
- Read the figures, dates and assumptions supplied in the question before calculating or interpreting an accounting result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What is the denominator in Cambridge's gearing formula?
What you will learn
- Explain gearing and the role of fixed financing commitments
- Calculate gearing using non-current liabilities and capital employed
- Interpret the result and evaluate ways of changing it
Gearing compares debt finance with capital
Gearing (%) = non-current liabilities ÷ capital employed × 100. In the Cambridge formula, capital employed = issued shares + reserves + non-current liabilities. Use the syllabus definition and the categories in the question.
A higher gearing ratio indicates a greater share of capital employed supplied by non-current liabilities. Debt can fund growth without issuing shares and may increase returns to shareholders if projects earn enough; interest and repayment commitments remain even when profits fall.
Interpret risk alongside earning capacity
Higher gearing can increase exposure to interest-rate changes, refinancing and weaker cash flows. It does not alone prove a business is unsafe: stability of operating cash, interest costs, debt maturity, asset base and sector norms matter.
Possible ways to reduce gearing include repaying debt, raising equity, retaining profit or selling assets and using proceeds to repay borrowing. Each can have a trade-off: equity dilutes control, retained profit may limit dividends or investment, and asset sales can reduce capacity. A higher ratio may also follow a strategic investment that later generates returns.
Pause and explain
Non-current liabilities are $40,000 and capital employed is $200,000. What is gearing?
Worked example
A company has non-current liabilities $60,000, issued shares $160,000 and reserves $40,000. Calculate gearing using Cambridge's formula.
Show the worked solution
- Capital employed=160,000+40,000+60,000=$260,000.
- Gearing=60,000÷260,000×100.
- Round the percentage suitably.
Answer Gearing is approximately 23.1%. This describes the debt share of capital employed; it is not a pass/fail risk score.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Issued shares are $250,000, reserves $50,000 and non-current liabilities $100,000. Calculate gearing.
Give me a hint
Build capital employed by adding all three components, then calculate the debt share.
Compare my reasoning
- Capital employed=250,000+50,000+100,000.
- Divide non-current liabilities by capital employed.
- Multiply by 100 to present a percentage.
Capital employed is $400,000; gearing is 100,000÷400,000×100=25%.
Look for these in your work
- All capital-employed components are included
- Non-current liabilities form the numerator
- Percentage is correct
A firm's gearing rises after it borrows to build a plant. Explain why this may increase financial risk and identify evidence needed to judge whether the borrowing is manageable.
Give me a hint
Fixed finance obligations matter, but the return and cash-flow pattern matter too.
Compare my reasoning
- Interest and repayment commitments increase.
- A downturn or rate rise can make those commitments harder to meet.
- Compare forecast operating cash, interest cost, maturity dates and expected plant utilisation.
Borrowing raises fixed commitments, so weaker trading or higher interest rates could pressure cash and repayment. To judge manageability, inspect operating cash-flow forecasts, interest cost, debt maturity, rate terms, demand and expected plant utilisation. The ratio alone cannot decide the issue.
Look for these in your work
- Fixed obligations are identified
- A downside scenario is explained
- Relevant evidence is selected
A board proposes issuing shares to repay half its long-term debt. Explain the likely ratio direction and assess one cost of the choice.
Give me a hint
If debt falls and equity rises, gearing normally falls, all else equal.
Compare my reasoning
- Non-current liabilities decrease.
- Issued share capital rises, increasing capital employed.
- Consider dilution, issue cost, control and the cash interest saved.
All else equal, gearing falls because non-current liabilities are lower and equity in capital employed is higher. The trade-off is that new shares may dilute existing ownership or control and can be costly to issue; the firm should compare that with lower interest and refinancing risk.
Look for these in your work
- Numerator and denominator effects are covered
- A shareholder trade-off is assessed
- Conclusion remains conditional
Common mistakes
- Using debt divided by equity when the syllabus formula is supplied
- Leaving non-current liabilities out of capital employed
- Calling low gearing automatically optimal
What can you explain now?
What is the denominator in Cambridge's gearing formula?
Compare with the explanation
Capital employed
It includes issued shares, reserves and non-current liabilities.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
What does Cambridge's gearing ratio measure, and which facts add meaning to the percentage?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.