Aspects

• Two variables determine a business's gap ratio. The first is the sum of all assets that are interest-sensitive. Such assets may be debts that other parties owe the business that are affected by interest rate fluctuations. The second is the sum of all liabilities that are interest-sensitive. Such liabilities may be variable-interest loans on which the business must make payments.
  
  

Calculation

• To calculate its gap ratio, a business must divide the total value of its interest-sensitive assets by the total value of its interest-sensitive liabilities. Once it has this quotient, the business may represent it as a decimal or as a percentage.
  
  

Application

• The purpose of calculating a gap ratio is to gauge how well a business can withstand sudden fluctuations in interest rates. A high number shows financial stability in light of possible interest rate fluctuations, while a low number shows financial instability. For instance, a lender with $3 million worth of interest-sensitive liabilities and $5 million worth of interest-sensitive assets is relatively stable because its gap ratio is approximately 1.67. However, if those numbers were reversed, its gap ratio would be 0.6, showing financial instability.
  
  

Limitations

• While the gap ratio can be useful as a sign of financial stability, it is not the only aspect of financial stability. For instance, if only a small portion of a company's total assets are heavily interest-sensitive, even if fluctuations occur, this may not have a heavy effect on financial stability or business solvency.