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Capital gearing


This term refers to the various types of capital assembled to fund a business - usually a company. Capital may be in shares or loans with a considerable variety of each category available, e.g. shares may be ordinary, preferential or deferred. They may be entitled to dividend, which is fixed or variable, cumulative or not. So also with loans, which may be long-term, middleterm or short-term and carry varying interest rates. They may also be 'convertible' i.e. lenders have a right to convert their loan into shares.

A business must always be aware of its future commitments and the managers' assessment of the future income flow will determine how they gear their capital, i.e. how it is spread among the various categories mentioned above. A company which anticipates an uneventful career with a fairly constant rate of profit may be content to be low-geared. It may be willing to raise the greater part of its capital by one issue of shares, part fixed dividend and part ordinary. Where the life of the business is unpredictable and depends on a great many predictable and depends on a great many unknown factors, it may be better to rely on a variety of fixed interest short-term loans which can be raised as and when necessary and which will come up for repayment or renewal at frequent intervals, preferably staggered. Such a business would be highly geared. Generally speaking, the greater the id of capital over various types and at various interest rates the higher the degree of capital gearing there is said to be.

From this it follows that the fortunes of ordinary shareholders are very much deterpart of the capital is raised in fixed interest securities then their dividend will vary quite disproportionately to profitability: nothing will come to them when profits are equal to. or less than, interest payable; however, above this level dividends could well rocket unexpectedly and unreservedly.


Reference: The Penguin Business Dictionary, 3rd edt.