Help Gearing

System
System Posts: 100,534 🤖 Admin 🤖
edited 10:28AM in AAT student discussion
Im looking on at some past papers relating to gearing. The Questions is:<BR><BR>Explain what the term gearing means. When might a high gearing ratio be financially opportune?<BR><BR>If anyone has any clue relating to this subject please leave a msg here or email me at andrewlau2003@hotmail.com<BR><BR>Many Thanks<BR><BR>Andy

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  • System
    System Posts: 100,534 🤖 Admin 🤖
    Help Gearing

    Gearing is the term used to describe the relationship between capital finance raised via 'Equity' ( selling shares in a company ) and capital finance raised via 'debt' ( bank loans, debentures etc)<BR><BR>A highly geared company is financed primarily by borrowings (debt) a low geared company has low debt and high owner or high private investor share capital.<BR><BR>The proper ratio of equity to debt has been extensively debated over the years and is subject to economic 'fashion and theory' If you raise finance for a company by selling shares you have to pay your shareholders a reasonable dividend for them to remain as investors and surrender a measure of control to them. This will maintain or increase the 'market'value of your company. If you borrow from institutions to finance your capital you obviously have to pay interest. However interest payable is tax deductable so a company can reduce its Corporation Tax liability.<BR><BR>Simplistically, debt interest can be cheaper than shareholder dividends. The caveat to this though is that highly geared companies can have too much debt which makes borrowing expensive as banks charge a premium interest rate because of their assumed extra risk.<BR><BR><BR>The gearing ratio is calculated as total debt / total assets<BR><BR>Hope this helps<BR><BR>David<BR><BR><BR><BR>

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