It's not always bad to have a high % of gearing debt to equity. It depends on the businesses position.
If it is in start up or expansion it is likely to have a higher % than if the business has settled in or at a steady state.
But in saying that, yes, it is generally bad to have a high % as it means the business is at risk due to interest rate/currency fluctuations.
It is also bad for a business to be under geared (having a % that is too low) as it means the business is not taking full advantage of its borrowing opportunities.
Our teacher says that generally 0.5 - 0.7 : 1 is good - which is 50% - 70%. But it changes depending on who you are talking to.
You can't state what level of gearing is "correct", every business has different aspects impacting upon their need or dependence to externally source.
This includes:
- The type of operations processes and how capital intensive they are. E.g Qantas' operations are very capital intensive compared to an online store, you can't expect them to both have one figure to determine correct gearing.
-Every industry is different, this kinda relates to the first point but some industries can have different expectations of the use of external finance
-Prepared risk which management is willing to take, and the risk-reward of this outcome
- Amount of available equity and retailed profits
Various more, but you get the point. People are different and so are businesses, the only gearing i would compare is between businesses in the same industry. I know this may be venturing away from businesses but in real estate generally 80% gearing is the accepted amount by banks (for a normal residential house, rural and commercial properties again have different levels) before LMI is required. So i would think up to 80%, however my teacher said up to 100%.
So no, a higher gearing is not generally bad, as long as the firm can effectively MANAGE these liabilities. This initial high level of gearing can be the key to substantial growth in the future, although if not maintained can cause a wealth of problems.
