Gearing = ((Total borrowings – cash) x 100) ÷ shareholders’ funds
Gearing is a term borrowed from engineering.
The diagram above shows that, if you have two adjacent cogs, turning the smaller one will rotate the larger one. The greater the difference, the more large rotations you get from rotating the small wheel. This is the principle of gears on cars and bicycles, where higher gearing is used for higher speeds.
In accounting, gearing similarly means the ratio of output to input in terms of financial return to the ordinary shareholder as measured by EPS (explained in Chapter 1).