Capital Gearing Ratio
Capital Gearing Ratio:
Definition and Explanation:
Closely related to solvency ratio is the capital gearing ratio. Capital gearing ratio is mainly used to analyze the capital structure of a company.
The term capital structure refers to the relationship between the various longterm form of financing such as debentures, preference and equity share capital including reserves and surpluses. Leverage of capital structure ratios are calculated to test the longterm financial position of a firm.
The term “capital gearing” or “leverage” normally refers to the proportion of relationship between equity share capital including reserves and surpluses to preference share capital and other fixed interest bearing funds or loans. In other words it is the proportion between the fixed interest or dividend bearing funds and non fixed interest or dividend bearing funds. Equity share capital includes equity share capital and all reserves and surpluses items that belong to shareholders. Fixed interest bearing funds includes debentures, preference share capital and other longterm loans.
Formula of capital gearing ratio:
[Capital Gearing Ratio = Equity Share Capital / Fixed Interest Bearing Funds]
Example:
Calculate capital gearing ratio from the following data:
Equity Share Capital Reserves & Surplus Long Term Loans 6% Debentures 
1991  1992 
500,000 300,000 250,000 250,000 
400,000 200,000 300,000 400,000 
Calculation:
Capital Gearing Ratio 1992 = (500,000 + 300,000) / (250,000 + 250,000) = 8 : 5 (Low Gear) 1993 = (400,000 + 200,000) / (300,000 + 400,000) 6 : 7 (High Gear) It may be noted that gearing is an inverse ratio to the equity share capital. Highly Geared————Low Equity Share Capital Low Geared—————High Equity Share Capital

Significance of the ratio:
Capital gearing ratio is important to the company and the prospective investors. It must be carefully planned as it affects the company’s capacity to maintain a uniform dividend policy during difficult trading periods. It reveals the suitability of company’s capitalization.
You may also be interested in other articles from “financial statement analysis” chapter:
 Horizontal and Vertical Analysis
 Ratios Analysis
 Horizontal Analysis or Trend Analysis
 Trend Percentage
 Vertical Analysis
 Accounting Ratios Definition, Advantages, Classification and Limitations:
 Gross profit ratio
 Net profit ratio
 Operating ratio
 Expense ratio
 Return on shareholders investment or net worth
 Return on equity capital
 Return on capital employed (ROCE) Ratio
 Dividend yield ratio
 Dividend payout ratio
 Earnings Per Share (EPS) Ratio
 Price earning ratio
 Current ratio
 Liquid/Acid test/Quick ratio
 Inventory/Stock turnover ratio
 Debtors/Receivables turnover ratio
 Average collection period
 Creditors/Payable turnover ratio
 Working capital turnover ratio
 Fixed assets turnover ratio
 Over and under trading
 Debttoequity ratio
 Proprietary or Equity ratio
 Ratio of fixed assets to shareholders funds
 Ratio of current assets to shareholders funds
 Interest coverage ratio
 Capital gearing ratio
 Over and under capitalization
 FinancialAccounting Ratios Formulas
 Limitations of Financial Statement Analysis
Other Related Accounting Articles:
 Screening Decisions and Preference Decisions
 Review Problem 2: Comparison of Capital Budgeting Methods
 Capital Budgeting Decisions
 Future Value and Present Value Tables
 Venture Capital Funding
 Capital Expenditures / Capital Cost
 Simple Rate of Return Method
 Present Value and Future Value – Explanation of the Concept
 Review Problem 1: Basic Present Value
 Income Tax and Capital Budgeting Decisions
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