Capital Gearing:

Capital gearing, also known as financial leverage, refers to the proportion of debt and equity in a company's capital structure. It indicates the extent to which a company relies on debt financing compared to equity financing. Capital gearing is an important aspect of financial management as it impacts the risk and return profile of a company.

Key Points:
- Definition: Capital gearing is the relationship between a company's debt and equity financing.
- Capital Structure: The capital structure of a company represents the mix of debt and equity used to finance its operations.
- Debt Financing: Debt financing involves raising funds by borrowing from banks, financial institutions, or issuing bonds. It includes both short-term and long-term debt.
- Equity Financing: Equity financing involves raising funds by issuing shares or retaining earnings. It represents the ownership stake of shareholders in the company.
- Gearing Ratio: The gearing ratio is a measure of capital gearing and is calculated by dividing the total debt by total equity. It indicates the level of financial risk and leverage in a company.
- High Gearing: A company with a high gearing ratio has a greater proportion of debt in its capital structure. While it can increase the return on equity, it also amplifies the risk as interest payments need to be made regardless of the company's performance.
- Low Gearing: A company with a low gearing ratio relies more on equity financing. It reduces the risk of bankruptcy but may limit the potential return on equity.
- Impact on Risk: High gearing increases the financial risk as higher interest payments can strain the company's cash flow. It also makes the company more vulnerable to economic downturns.
- Impact on Return: Capital gearing can magnify the return on equity for a company with high gearing, as the cost of debt is typically lower than the return on investment. However, it also increases the volatility of returns.
- Optimal Gearing: The optimal gearing ratio varies depending on the industry, market conditions, and company's risk appetite. It is important for companies to strike a balance between risk and return when determining their capital structure.

Overall, capital gearing plays a crucial role in financial management, impacting the risk and return trade-off for a company. Careful consideration and analysis of the optimal gearing ratio are essential to ensure the long-term sustainability and profitability of a business.