Capital Gearing Ratio Calculation
The capital gearing ratio indicates the capital structure of a company by
showing the ratio of equity capital to the borrowed capital. It is calculated by
dividing the equity capital of the company by the debt capital.
Illustration
Let's take an illustrative balance sheet:
Total assets for year 1: 1700
Total assets for year 2: 1835
Preference capital (capital raised with a fixed return): 650
Reserves (accumulated over the years): 250 for year 1 and 990 for year 2
Long-term liabilities: 625
Short-term liabilities: 375
The capital gearing ratio can be calculated as follows:
Fixed cost capital: 625 + 375 = 1000
Equity share capital: 650 + 990 = 1640
Capital gearing ratio in absolute numbers: 1.44 (fixed cost capital) and 1.52
(equity share capital)
Capital gearing ratio in percentage terms: 144% (equity share capital)
Therefore, the capital gearing ratio is 1.44 of the fixed cost capital and 1.52 of
the equity share capital.
Implications of a High Capital Gearing Ratio
In case of a highly geared entity, the cost of borrowing becomes high and the
options become restricted as bankers and financial institutions are reluctant to
lend. If the entity requires additional borrowing, the cost of borrowing will
increase further. Therefore, debt servicing has to be carefully monitored since
equity capital is less.
Financial leverage at proper levels helps expanding the business. However, if
the entity is highly geared, it further impacts the overall financials of the entity.
The capital gearing ratio indicates the capital structure of a company by
showing the ratio of equity capital to the borrowed capital. It is calculated by
dividing the equity capital of the company by the debt capital.
Illustration
Let's take an illustrative balance sheet:
Total assets for year 1: 1700
Total assets for year 2: 1835
Preference capital (capital raised with a fixed return): 650
Reserves (accumulated over the years): 250 for year 1 and 990 for year 2
Long-term liabilities: 625
Short-term liabilities: 375
The capital gearing ratio can be calculated as follows:
Fixed cost capital: 625 + 375 = 1000
Equity share capital: 650 + 990 = 1640
Capital gearing ratio in absolute numbers: 1.44 (fixed cost capital) and 1.52
(equity share capital)
Capital gearing ratio in percentage terms: 144% (equity share capital)
Therefore, the capital gearing ratio is 1.44 of the fixed cost capital and 1.52 of
the equity share capital.
Implications of a High Capital Gearing Ratio
In case of a highly geared entity, the cost of borrowing becomes high and the
options become restricted as bankers and financial institutions are reluctant to
lend. If the entity requires additional borrowing, the cost of borrowing will
increase further. Therefore, debt servicing has to be carefully monitored since
equity capital is less.
Financial leverage at proper levels helps expanding the business. However, if
the entity is highly geared, it further impacts the overall financials of the entity.
