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# Capital Gearing Ratio:

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## Definition and Explanation:

It is the ratio between the capital plus reserves i.e. equity and fixed cost bearing securities. Fixed cost bearing securities include debentures, long term mortgage loans etc.

In a company form of organization, real risk is borne by equity shareholders because they are entitled to whatever residue is left after all others have been paid at the contracted rate.

This ratio measures the extent of capitalization by the funds raised by the issue of fixed cost securities. This ratio is interpreted by the use of two terms.

Highly geared mean lower proportion of equity. Low geared means high proportion of equity as compared to fixed cost bearing capital.

## Formula:

The formula/equation for the calculation of capital gearing ratio is as follows:

Capital gearing ratio = Equity / Fixed cost bearings securities

Where,

Equity = Equity share capital + Free reserves + Profits and loss account credit balance

Fixed cost bearing securities =  Debentures + Long term loans

## Significance:

Capital gearing must be carefully planned. Financial management gives us a concept of "Trading on Equity". It means as long as rate of earnings of business is higher than cost of fixed interest/dividend bearings securities the equity shareholders gain on the strength of their equity. Reverse follows in alternative situations.

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## More study material from this topic: Meanings, Nature and Usefulness of Ratios Analysis Interpretation of Ratios Important Factors for Understanding Ratios Analysis Significance and Usefulness Ratios Analysis Classification of Ratios Analysis of Short Term Financial Position or Test of Liquidity Current Ratio Quick/Acid Test/Liquid Ratio Absolute Liquid Ratio Inventory/Stock Turnover Ratio Debtors / Receivable Turnover Ratio Creditors / Payables Turnover Ratio Working Capital Turnover Ratio Profitability Ratios Gross Profit Ratio (GP Ratio) Operating Profit Ratio Net profit ratio (NP ratio) Earnings Per Share Ratio Operating ratio Expense ratio Solvency ratios - Test of Long Term Solvency Debt-equity Ratio Debt Service Ratio or Interest Coverage Ratio Fixed Assets Ratio Debts to Total Funds or Solvency Ratio Reserves to Capital Ratio Capital Gearing Ratio Proprietary Ratio Accounting Ratios Formulas Limitations of Ratios Analysis

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