Which statement best describes gearing?

Which statement best describes gearing?

• A. High gearing indicates heavy reliance on long-term debt financing.
• B. High gearing indicates high liquidity.
• C. High gearing indicates high profitability.
• D. High gearing indicates low current assets.

Answer: (A)

Gearing is about financial leverage—the extent to which a company is financed by debt relative to equity. When gearing is high, the firm relies heavily on long‑term debt to fund its activities, which increases fixed interest obligations and financial risk but can also magnify returns if profits rise. This is why the statement describing heavy reliance on long‑term debt financing is the best one. Gearing does not measure liquidity (that’s about the ability to meet short‑term obligations), nor does it directly indicate profitability (returns can be amplified or reduced by debt but gearing itself isn’t a profit measure). It also doesn’t inherently imply low current assets—the level of current assets is a separate liquidity matter and gearing focuses on long‑term debt versus equity.

Gearing is about financial leverage—the extent to which a company is financed by debt relative to equity. When gearing is high, the firm relies heavily on long‑term debt to fund its activities, which increases fixed interest obligations and financial risk but can also magnify returns if profits rise. This is why the statement describing heavy reliance on long‑term debt financing is the best one. Gearing does not measure liquidity (that’s about the ability to meet short‑term obligations), nor does it directly indicate profitability (returns can be amplified or reduced by debt but gearing itself isn’t a profit measure). It also doesn’t inherently imply low current assets—the level of current assets is a separate liquidity matter and gearing focuses on long‑term debt versus equity.