Gearing refers to the relationship between a company’s debt and its equity. If this ratio is high, the company may be vulnerable as a majority of the cash flows will be directed towards debts. On the other hand, if cash flow is strong, after debts are paid off, their shareholders can reap the benefits.
For example…
Let’s consider an augmented reality game development shop called QuiteReal. They have taken on a few debts to research and develop solutions, buy equipment, test and improve the project. This equals about a hundred thousand dollars. The company already generates cash flow from its existing operations, equalling about sixty thousand dollars. This means the debt to equity ratio is sixty percent. This may not be excessive, but being a technology company, which is subject to significant change, it means QuiteReal needs to be mindful of the relatively high gearing ratio going forwards.
