What is Capital Gearing?
The term capital gearing refers to the ratio of debt a company has relative to equities. Capital gearing represents the financial risk of a company. It is also referred to as financial gearing or financial leverage. A company is said to have a high capital gearing if the company has a large debt as compared to its equity.
For example, if a company is said to have a capital gearing of 3.0, it means that the company has debt thrice as much as its equity.
Understanding Capital Gearing
The ratio of capital gearing may differ with respect to the industry a company is in. Industries that require a large capital investment may have a high capital gearing ratio.
Capital gearing ratio acts as one of the major factors based on which lenders and investors consider a company. If the company has a high capital gearing ratio, it creates a negative impression in the minds of lenders as the company won't be able to make the repayments in case there is a slowdown in its operations. Similarly, investors consider the companies in cyclical industries risky.
In contrast, companies with a high gearing ratio from a stable industry may not pose a serious threat to lenders and investors. Consider the case of the utility sector. Companies in this sector need high capital investments, and hence, their capital gearing ratio will be obviously high. However, they are the monopolies, and their rate is highly regulated. Therefore, their revenues stay highly stable.
At times, companies may increase gearing in order to finance a leveraged buyout or acquire another company.
