Pros and cons of gearing ratios
Pros of gearing ratios
A gearing ratio is a useful measure for the financial institutions that issue loans, because it can be used as a guideline for risk. When an organisation has more debt, there is a higher risk of financial troubles and even bankruptcy.
Gearing ratios are also a convenient way for the company itself to manage its debt levels, predict future cash flow and monitor its leverage.
Cons of gearing ratios
Using a company’s gearing ratio to gauge its financial structure does have its limitations. This is because the gearing ratio could reflect a risky financial structure, but not necessarily a poor financial state. While the figure gives some insight into the company’s financials, it should always be compared against historical company ratios and competitors’ ratios.