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Capital gearing ratio represents the relationship between equity share capital of a firm and its fixed interest bearing funds. Fixed interest bearing funds include preference share capital, debentures, bonds and other type of loans which bear a fixed rate of interest on it.
This ratio is used to measure the ‘degree of leverage’ of a firm. A firm having low capital gearing ratio will be called as highly leveraged and vice versa.
Formula for computing capital gearing ratio:
Capital gearing ratio can be calculated by using below given formula:
Equity share capital / fixed interest bearing funds
Equity share capital refers to total share capital minus preference share capital.
Let’s assume that ABC Ltd Company has following figures on its balance sheet:
|Equity share capital||1,00,00,000||90,00,000|
|Preference share capital||28,00,000||45,00,000|
Using the above given figures, we are able to calculate capital gearing ratio for year 2012 and 2013 separately.
For the year 2012:
1,00,00,000 / 80,00,000 = 1.25 : 1
For the year 2013:
90,00,000/ 1,12,50,000 = 0.8 : 1
The above results show that the company was low geared (leveraged) in 2012 whereas it was highly geared (leveraged) in the year 2013.