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(171)-CAPITAL GEARING RATIO

Sunday, May 9, 2010

Capital Gearing Ratio

The capital gearing ratio is a measure of the proportion of a company’s capital that is prior charge capital. It is measured as follows:

Capital gearing ratio = Prior charge capital / Total capital

Prior charge capital is capital carrying a right to fixed return. It will include preference shares and debentures.

Total capital is ordinary share capital and reserves plus prior charge capital plus any long-term liabilities or provisions. In group accounts we would also include minority interests. It is easier to identify the same figure for total capital as total assets less current liabilities, which you will find given to you in the balance sheet.

As with the debt ratio, there is no absolute limit to what a gearing ratio ought to be. A company with a gearing ratio of more than 50% is said to be high geared (where low gearing means a gearing ratio of less than 50%). Many companies are high geared, but if a high geared company is becoming increasingly high geared, it is likely to have difficultly in the future when it wants to borrow even more, unless it can also boost its shareholders’ capital, either with retained profits or by a new share issue.

A similar ration to the gearing ratio is the debt/equity ratio, which is calculated as follows.

Debt/equity ratio = Prior charge capital / Ordinary share capital and reserves

This gives us the same sort of information as the gearing ratio, and a ratio of 100% or more would indicate high gearing.

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