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The capital gearing ratio is a financial metric used to examine how a company funds its operations by comparing fixed-interest obligations with equity capital. It forms part of leverage analysis and is commonly referenced when reviewing capital structure and long-term financial positioning.
The capital gearing ratio measures the proportion of fixed-interest-bearing funds (such as loans, debentures, and preference shares) relative to equity shareholders’ funds. It indicates whether a company relies more on borrowed capital or shareholder capital to finance its activities.
A higher ratio reflects greater dependence on fixed financial obligations, while a lower ratio shows a larger equity base within the capital structure.
The formula is:
Capital Gearing Ratio = Fixed Interest Bearing Funds ÷ Equity Shareholders’ Funds
Where:
Fixed Interest Bearing Funds = Debentures + Loans + Preference Shares
Equity Shareholders’ Funds = Equity Share Capital + Reserves + Surplus
The ratio expresses how fixed-charge capital compares with shareholder-owned funds.
Suppose Company A has the following capital structure:
Debentures = ₹50,00,000
Preference Shares = ₹20,00,000
Loans = ₹30,00,000
Equity Share Capital + Reserves = ₹1,00,00,000
Fixed Interest Bearing Funds = ₹1,00,00,000
Equity Shareholders’ Funds = ₹1,00,00,000
Capital Gearing Ratio = ₹1,00,00,000 ÷ ₹1,00,00,000 = 1:1
This means the company has an equal proportion of debt and equity financing.
The capital gearing ratio provides insight into how a company structures its financing and manages fixed financial commitments.
Financial Risk Exposure: Indicates the level of fixed payment obligations within the capital structure.
Earnings Sensitivity: Higher gearing can lead to wider fluctuations in net earnings during changing business conditions.
Credit Evaluation: Lenders review gearing to assess repayment capacity.
Profit Allocation: A higher proportion of fixed capital means a larger share of operating profits is allocated toward interest or preference dividends.
Capital Structure Assessment: Shows whether funding is weighted toward debt or equity.
Overall, the ratio supports evaluation of leverage alongside other financial indicators.
Capital gearing is generally classified into two categories:
| Type | Meaning | Implication |
|---|---|---|
High Gearing |
Larger proportion of fixed-interest capital |
Greater financial obligation exposure |
Low Gearing |
Higher reliance on equity capital |
Lower fixed payment commitments |
Despite its relevance, the capital gearing ratio has certain constraints:
Does not reflect profitability or operating performance.
Varies significantly across industries, limiting direct comparison.
Excludes short-term liquidity considerations.
Can be affected by one-time changes in reserves or borrowing levels.
The capital gearing ratio outlines the balance between fixed-interest funding and equity within a company’s capital structure. While it highlights leverage levels, it does not capture profitability, cash flow strength, or operational efficiency. As a result, it is commonly presented alongside other financial measures to provide a broader view of corporate capital structure.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The capital gearing ratio is also referred to as the gearing ratio or financial leverage ratio, reflecting the proportion of fixed-interest capital relative to equity.
High capital gearing indicates a larger share of fixed-interest obligations within the capital structure, increasing exposure to mandatory interest and repayment commitments.
Low capital gearing reflects greater reliance on equity financing, resulting in fewer fixed financial charges.
While both ratios measure leverage, they differ in focus. The capital gearing ratio compares fixed-interest bearing funds (such as loans, debentures, and preference shares) with equity, showing how much of the capital carries mandatory charges. The debt-equity ratio, on the other hand, compares the total debt of a company to its equity capital, giving a broader picture of financial leverage.
The capital gearing ratio compares fixed-interest funds with equity, while the debt-equity ratio compares total debt with equity, offering a broader view of leverage.
The ratio illustrates how financial obligations are structured and how earnings may fluctuate under varying business conditions.
It is calculated by dividing fixed-interest-bearing funds (loans, debentures, preference shares) by equity shareholders’ funds.
Higher gearing increases exposure to fixed payment commitments, while lower gearing reduces dependence on mandatory charges.
Yes. Capital structures differ widely by sector, making industry context important when reviewing gearing levels.
The ratio shows how shareholder capital compares with fixed-interest funding, indicating the degree of leverage within the company.
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Posted on 19 Dec
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