Capital Gearing Ratio
It is a ratio showing the relationship of the company between the owners’ funds and external funds with fixed payout commitments. A company with more equity is termed as a low-geared company as it does not have a high liability of paying off fixed interest or dividends. While a company having more fixed cost-bearing funds is referred to as highly geared. The calculation of the capital gearing ratio calculator is important in the case of raising more money using the debt option. The lenders may not be willing to lend money to a company which is already having more fixed cost-bearing funds in its capital structure or a company that is highly geared.
In order to calculate the capital gearing ratio, we divide common shareholders’ funds or common shareholders’ equity by fixed cost-bearing funds. A mathematical representation of the same is as follows:
Capital Gearing Ratio = Common Shareholders’ Equity / Fixed Cost Bearing Funds
How to Calculate using Calculator?
The user has to enter the following figures into the calculator:
Common Shareholders’ Equity
It refers to all the funds belonging to equity shareholders of the company. These funds include capital contributed by equity shareholders and the accumulated profit of the company. These accumulated profits or reserves of the company belong to the company’s equity shareholders as it is the profit that the company retains after paying off all the fixed obligations, including preference dividends.
Fixed Cost Bearing Funds
Fixed cost-bearing funds refer to such sources of funds that come with an obligation of fixed payments. It includes long-term borrowings (bank loans, bonds, debentures, etc.) plus preference capital.
Assume that a company has $90,000 as equity share capital and $450,000 as reserves and surplus. The sources of funds with fixed charges of the company include 5% debentures of 300,000, 12% preferred stock of $250,000, and short-term borrowings of $260,000.
Owners’ Funds or Equity Shareholders’ Funds = 90,000 + 450,000 = 540,000
Fixed Cost Bearing Funds = 300,000 + 250,000 + 260,000 = 820,000
Capital Gearing Ratio = 540,000 / 810,000 = 2:3 Or 0.67:1.
Here, the company has more funds that bear a fixed cost in comparison to the owners’ funds. This states that the company is highly geared.
This ratio is also financial leverage for the company. And, we generally consider financial leverage good for a company provided that the company has enough earning capacity to discharge its fixed payment obligations regularly.