What Is Financial Gearing?
Financial gearing is just one example of all the myriad of terms relating to money matters and finance that most people do not understand. If your financial situation is not affected by financial gearing in any way, then you probably have no reason to know what this term means. However, if your finances could be affected by it, it is in your best interest to know a little about what it means instead of always relying on someone else to know what it means and make the best decision for you. Financial gearing is actually not that hard to comprehend, and knowing a simple explanation can help you understand more about investments and risk.
Financial Gearing: Continued Explanation...
Financial gearing actually means something entirely different than most people would guess. It refers to the relationship between a company’s debt and the equity it has from its shareholders. Expressed as a percentage, you can easily calculate the financial gearing if you have those two figures because it is obtained by dividing the debt by the shareholders’ equity.
Whether a company has a high or low financial gearing is a significant predictor of its success and risk. A high financial gearing results from having a high proportion of debt to equity and a low financial gearing is where that proportion is much lower. If a company has a large amount of debt in proportion to its equity, it can be an indicator that the company may have problems in the future paying its debts effectively. Investing in these kinds of companies is generally considered a risky investment.
Ultimately, financial gearing is a much more important figure than simply the amount of debt a company has because a company with an extraordinarily large debt but also large equity can have a low financial gearing and low-risk status, while another company with a very small debt but a very small equity can have a high financial gearing and high-risk status. Therefore, in many cases a company with a higher debt could be a lower risk investment than a company with a lower debt if the shareholders’ equity is greater.
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