Financial Accounting · Ratios

Gearing Ratio and Interest Cover for ACCA FA

Updated 11 October 2026 · Fact-checked

Gearing measures how much of a company's long-term finance comes from debt rather than equity. Calculate it as debt ÷ equity, or debt ÷ (debt + equity). Interest cover measures how easily profit pays finance costs: profit before interest and tax ÷ finance costs. Higher gearing and lower cover mean higher financial risk.

Understand Gearing Ratios

A company funds itself with equity (share capital and reserves) and debt (loans, loan notes and similar borrowings). Gearing shows the mix between the two. A company with a lot of debt is highly geared.

Debt matters because interest must be paid whether or not the company makes a profit. Dividends can be cut in a bad year. Interest cannot. So more debt means more financial risk. Lenders may refuse to lend more, or may charge a higher rate. If the company cannot pay, lenders can take action against it.

Debt is not always bad. Interest is usually tax deductible, and debt can be cheaper than equity. When profits are high, shareholders keep the extra profit after interest. A highly geared company can therefore give high returns in good years and very poor returns in bad years. Profits become more volatile.

Interest cover looks at the same risk from the income side. Gearing is about the statement of financial position. Interest cover is about the statement of profit or loss. It shows how many times profit before interest and tax could pay the interest bill. A low figure means little safety if profit falls.

Lenders use both ratios to judge whether a loan is safe. Investors use them to judge how risky and volatile their returns may be. Always read them together with the trend and with similar companies.

Key formulas to remember

Gearing (debt to equity): Gearing = Debt ÷ Equity × 100%; Debt means long-term borrowings, including loan notes and preference shares treated as debt. Equity means share capital plus all reserves.
Gearing (debt to capital employed): Gearing = Debt ÷ (Debt + Equity) × 100%; Debt + equity is capital employed in this version. Same company, different answer from debt ÷ equity. Use the version the question asks for.
Interest cover: Interest cover = Profit before interest and tax ÷ Finance costs; Answer is in times, such as 4.0 times. Use profit from operations before finance costs and tax.
Capital employed: Capital employed = Equity + Non-current liabilities; Useful check on the denominator. Include only interest-bearing debt in the debt figure.

How to solve Gearing Ratios questions

Use this method for any gearing or interest cover question.

1Read which formula the question asks for. Note whether it is debt ÷ equity or debt ÷ (debt + equity).
2Find debt. Take long-term borrowings, loan notes and any redeemable preference shares shown as liabilities. Leave out trade payables, tax and provisions unless told otherwise.
3Find equity. Add share capital, share premium and all reserves, including retained earnings.
4Calculate gearing and give it as a percentage, rounded as the question asks.
5For interest cover, find profit before interest and tax, and the finance costs. Divide and give the answer in times.
6Compare with the prior year or another company, if given. Say whether risk rose or fell.
7If asked to comment, link the numbers to risk for lenders and the volatility of returns for shareholders.

Quickest way: Three-number shortcut

When to use it: Use this for number entry or multiple choice questions where the data is clearly laid out.

Write the formula at the top of your scrap paper first.
Pick out only three numbers: debt, equity, and for cover, operating profit and finance costs.
Check debt does not include payables. Check equity includes retained earnings.
Do the division once and check the answer is sensible. Gearing between 0% and 100% for debt to capital employed is normal.
Match your answer to the option and rounding requested.

Common mistakes in Gearing Ratios

Mixing up the two gearing formulas.
Both are called gearing and both are used in textbooks.
Fix: Read the question wording. Debt ÷ equity can exceed 100%. Debt ÷ (debt + equity) cannot. If neither is stated, show your formula clearly.
Including trade payables or tax in debt.
All liabilities look alike on the statement of financial position.
Fix: Only include interest-bearing borrowings, normally long-term. Ignore trade payables, tax and provisions.
Leaving reserves out of equity.
Students take share capital only.
Fix: Equity is share capital plus share premium plus all reserves, including retained earnings and revaluation surplus.
Using profit after interest for interest cover.
The first profit figure noticed is often profit before tax.
Fix: Add finance costs back to profit before tax to get profit before interest and tax, then divide by finance costs.
Saying high gearing is always bad.
Students learn that debt means risk and stop there.
Fix: Say it raises financial risk and volatility, but can boost returns to shareholders when profit is strong. Judge it against industry and cover.
Giving interest cover as a percentage.
Other ratios are percentages.
Fix: Interest cover is a multiple. Write 5 times, not 500%.

Worked examples

Example 1

A company has share capital of $200,000, retained earnings of $300,000, a 7% loan note of $250,000 and trade payables of $90,000. Calculate gearing as debt ÷ equity.

Show the solution

Debt is the loan note only: $250,000. Trade payables are excluded.
Equity = $200,000 + $300,000 = $500,000.
Gearing = 250,000 ÷ 500,000 = 0.5.
As a percentage, 0.5 × 100 = 50%.

Answer: Gearing is 50%.

Example 2

A company reports profit before tax of $84,000 after finance costs of $16,000. Its long-term borrowings are $200,000 and its equity is $600,000. Calculate interest cover and gearing as debt ÷ (debt + equity), and comment briefly.

Show the solution

Profit before interest and tax = 84,000 + 16,000 = $100,000.
Interest cover = 100,000 ÷ 16,000 = 6.25 times.
Capital employed = 200,000 + 600,000 = $800,000.
Gearing = 200,000 ÷ 800,000 = 25%.
Comment: gearing is low and profit covers interest over six times, so financial risk is low and lenders are likely to see the company as safe.

Answer: Interest cover is 6.25 times and gearing is 25%, indicating low financial risk.

Exam tips

Check the formula wording before you calculate. Many wrong answers come from using the wrong gearing version.
In multiple response questions on gearing, remember that high gearing raises risk and volatility of returns, and does not by itself mean losses.
For number entry, match the rounding and unit asked: percentage for gearing, times for interest cover.
When a question gives profit before tax, add back finance costs before calculating interest cover.
Interpretation questions expect a direction and a reason: for example, cover fell, so profit gives less protection for lenders.

Practice questions from Ratios

Gearing Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Gearing Ratios: frequently asked questions

What is the gearing ratio formula in ACCA FA?

The two common versions are debt ÷ equity and debt ÷ (debt + equity), both as percentages. Debt means long-term interest-bearing borrowings. Equity means share capital plus reserves. Follow the version in the question.

How do I calculate interest cover?

Divide profit before interest and tax by finance costs. The answer is in times. If you only have profit before tax, add finance costs back first.

What is the difference between gearing and interest cover?

Gearing looks at the mix of debt and equity in the statement of financial position. Interest cover looks at whether profit can pay the interest in the statement of profit or loss. Gearing shows the debt level and interest cover shows the ability to service it.

What are the risks of high gearing for a company?

Interest must be paid even in a poor year, so profits and cash flow can be put under pressure. Lenders may refuse more credit or charge more. Returns to shareholders also become more volatile.