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Capital Gearing Ratio:

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Definition and Explanation:

It is the ratio between the capital plus reserves i.e. equity and fixed cost bearing securities. Fixed cost bearing securities include debentures, long term mortgage loans etc.

In a company form of organization, real risk is borne by equity shareholders because they are entitled to whatever residue is left after all others have been paid at the contracted rate.

This ratio measures the extent of capitalization by the funds raised by the issue of fixed cost securities. This ratio is interpreted by the use of two terms.

Highly geared mean lower proportion of equity. Low geared means high proportion of equity as compared to fixed cost bearing capital.

Formula:

The formula/equation for the calculation of capital gearing ratio is as follows:

Capital gearing ratio = Equity / Fixed cost bearings securities

Where,

Equity = Equity share capital + Free reserves + Profits and loss account credit balance

Fixed cost bearing securities =  Debentures + Long term loans

Significance:

Capital gearing must be carefully planned. Financial management gives us a concept of "Trading on Equity". It means as long as rate of earnings of business is higher than cost of fixed interest/dividend bearings securities the equity shareholders gain on the strength of their equity. Reverse follows in alternative situations.

More study material from this to
 

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis

 

 
 

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Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 
 

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