Capital gearing is concerned with a company’s long-term capital structure. We can think of a company as consisting of fixed assets and current assets (working capital, which is current assets minus current liabilities). These assets must be financed by long-term capital of the company, which is either:
- Share capital and reserves (shareholders’ funds) which can be divided into: Ordinary share plus reserves, and preference shares.
- Long-term debt capital: creditors: amounts falling due after more than one year.
Preference share capital is not debt. It would certainly not be included as debt in the debt ratio. However, like loan capital, preference share capital has a prior claim over profits before interest and tax, ahead of ordinary shareholders. Preference dividends must be paid out of profits before ordinary shareholders are entitled to an ordinary dividend, and so we refer to preference share capital and loan capital as prior charge capital.