Gearing Ratio

In Singapore’s competitive business environment, many companies use debt to finance growth. Borrowing allows businesses to expand operations, buy equipment, or smooth cash flow. But too much debt can turn opportunity into crisis. That’s where the gearing ratio comes in. It measures the relationship between a company’s debt and equity, showing how “leveraged” the business is. For business owners, monitoring gearing is essential to maintain credibility with banks, reassure investors, and protect the company’s survival during downturns.

Raffles Corporate Services works with a panel of experienced Singapore law firms who offer cost-effective and efficient legal service and advice. This article is general information only and is not legal advice.

What Is the Gearing Ratio?

The gearing ratio is a financial metric that compares a company’s debt to its equity or other measures of financial strength. It answers a critical question:

How much of the business is financed by borrowed money versus the owners’ own capital?

Common Gearing Formulas

1. Debt-to-Equity Ratio (D/E): Total Debt÷Shareholders’ Equity\text{Total Debt} ÷ \text{Shareholders’ Equity}Total Debt÷Shareholders’ Equity

2. Net Debt-to-EBITDA: (Total Debt–Cash)÷EBITDA(\text{Total Debt} – \text{Cash}) ÷ \text{EBITDA}(Total Debt–Cash)÷EBITDA

3. Debt-to-Assets: Total Debt÷Total Assets\text{Total Debt} ÷ \text{Total Assets}Total Debt÷Total Assets

4. Interest Coverage: EBIT÷Interest Expense\text{EBIT} ÷ \text{Interest Expense}EBIT÷Interest Expense

Each formula provides different insights. Banks often rely on Net Debt-to-EBITDA and Interest Coverage to assess loan affordability.

Practical Example: Singapore SME

A manufacturing SME has:

• Debt: S$8 million

• Cash: S$2 million

• Equity: S$6 million

• EBITDA: S$3 million

• Interest Expense: S$0.9 million

Calculations:

• Debt-to-Equity: 8 ÷ 6 = 1.33 (moderate to high leverage).

• Net Debt-to-EBITDA: (8 – 2) ÷ 3 = 2.0× (acceptable, but tight if revenues fall).

• Interest Coverage: 2.7 ÷ 0.9 = 3.0× (banks prefer >3.0×, so borderline).

This SME should consider reducing debt or increasing earnings before approaching lenders for new financing.

Why the Gearing Ratio Matters

1. Bank Lending Decisions

Banks use gearing ratios to determine creditworthiness. Higher gearing means higher risk, which can result in:

• Loan rejections.

• Higher interest rates.

• Stricter covenants.

2. Investor Confidence

Equity investors prefer businesses that balance debt with equity. Overleveraging can deter investors or force heavy dilution in future fundraising.

3. Business Resilience

Companies with high gearing are more vulnerable to interest rate hikes, revenue downturns, or unexpected expenses.

4. Governance and Compliance

For listed companies in Singapore, the gearing ratio is scrutinised by analysts and regulators. A consistently high ratio can trigger shareholder concerns and regulatory queries.

Sector Benchmarks in Singapore

• Property & Real Estate Investment Trusts (REITs): Often have high gearing (up to 45–50%) because stable rental income supports repayment.

• Manufacturing & Logistics: Moderate gearing (30–50%) is common due to equipment financing.

• Tech Startups: Typically low gearing; they rely more on equity financing.

• Professional Services: Low gearing, as they are asset-light.

For SMEs, the “right” gearing ratio depends on industry norms, growth stage, and revenue stability.

Risks of High Gearing

1. Debt Spiral: Rising interest payments eat into profits, leading to more borrowing.

2. Covenant Breaches: Violating loan terms (e.g., Net Debt-to-EBITDA > 3.0×) can trigger penalties or forced repayment.

3. Loss of Flexibility: Overleveraged firms cannot borrow further when opportunities arise.

4. Bankruptcy Risk: In extreme cases, insolvency if debts cannot be serviced.

Managing and Improving Gearing

1. Increase Profits (Boost Equity Base)

• Improve margins through pricing strategies.

• Expand into higher-value segments.

• Streamline costs.

2. Reduce Debt

• Refinance high-interest loans with longer tenors.

• Prepay loans using surplus cash.

• Dispose of non-core assets to repay debt.

3. Strengthen Equity

• Retain earnings instead of distributing all profits.

• Raise new equity from investors.

• Consider hybrid instruments (e.g., redeemable preference shares, convertible notes).

4. Manage Cash Flow

• Tighten receivables collection.

• Negotiate longer payment terms with suppliers.

• Improve inventory turnover.

5. Stress-Test Scenarios

Regularly test how your gearing and interest coverage would change if:

• Revenue drops 20%.

• Interest rates rise 2%.

• Exchange rates shift unfavourably.

Case Study: Logistics Company in Singapore

A logistics company financed fleet expansion with debt, pushing its Debt-to-Equity ratio to 2.0. Rising fuel costs and interest rates squeezed margins.

To stabilise, the company:

• Sold underutilised trucks to cut debt.

• Raised S$2 million in equity from a strategic partner.

• Reduced Debt-to-Equity to 1.0, improving bank confidence.

Within a year, it regained the capacity to borrow for new contracts, this time on better terms.

Best Practices for Singapore Business Owners

1. Track Ratios Quarterly: Monitor gearing alongside other KPIs like current ratio and ROE.

2. Negotiate Covenants Carefully: Avoid overly restrictive terms that limit flexibility.

3. Maintain Liquidity Buffers: Keep cash reserves or standby credit lines.

4. Balance Growth and Prudence: Leverage debt for expansion, but avoid overextending.

5. Seek Professional Advice: Accountants and financial advisors can benchmark gearing against peers.

Conclusion: Gearing as a Strategic Compass

The gearing ratio is not just a number—it’s a strategic compass. For Singapore business owners, it signals when to borrow boldly, when to slow down, and when to seek equity partners. A healthy gearing ratio reassures banks, attracts investors, and keeps your business resilient in downturns. By managing debt wisely, you ensure that leverage works for you, not against you.