MEANING AND SIGNIFICANCE OF CAPITAL GEARING FOR NET COMMERCE/MANAGEMENT

·               MEANING OF CAPITAL GEARING
FOR NET COMMERCE/MANAGEMENT
FINANCIAL MANAGEMENT

• MEANING OF CAPITAL GEARING

1. BRITISH TERM THAT REFERS TO THE AMOUNT OF DEBT A COMPANY HAS RELATIVE TO ITS EQUITY
2. IN THE UNITED STATES CAPITAL GEARING IS KNOWN AS FINANCIAL LEVERAGE
3. THE TERM CAPITAL GEARING REFERS TO THE RELATIONSHIP BETWEEN EQUITY CAPITAL ( EQUITY SHARE PLUS RESERVE) AND LONG TERM DEBT.
4. MAY BE PLANNED OR HISTORICAL
5. IN SIMPLE WORD WE CAN SAY CAPITAL GEARING MEANS THE RATIO BETWEEN THE VARIOUS TYPES OF SECURITIES IN THE CAPITAL STRUCTURE OF THE COMPANY.
6. FORMULA
7. CAPITAL GEARING RATION: EQUITY/FIXED COST BEARING SECURITIES
8. EQUITY MEANS : EQUITY SHARE CAPITAL + FREE RESERVE + PROFITS AND LOSS ACCOUNT CREDIT BALANCE
9. FIXED COST BEARING SECURITIES = DEBENTURES + LONG TERM LOANS+ PREFERENCE SHARE CAPITAL

• CAPITAL GEARING
• HIGH GEAR: WHEN THE ORGANIZATION HAS PROPORTIONATELY HIGHER LARGER ISSUE OF DEBENTURES AND PREFERENCE SHARES FOR RAISING THE LONG TERM RESOURCES
• LOW GEAR : WHEN THE COMPANY HAS PROPORTIONATELY LARGE ISSUE OF EQUITY SHARES
• EXAMPLE
• EXPLANATION
• THE TOTAL CAPITALIZATION OF THE ABOVE COMPANIES IS THE SAME THAT IS ONE CRORE FOR EACH COMPANY BUT X LTD IS HIGH GEARED HAVING 60% IS THE PROPORTION OF DEBENTURES AND PREFERENCE SHARES AND Y LTD IS LOW GEARED HAVING 60 % IS THE PROPORTION OF EQUITY CAPITAL
• SIGNIFICANCE OF CAPITAL

1.     DIRECT BEARING ON THE DIVISIBLE PROFITS OF THE COMPANY AND PROPER GEARING IS VERY IMPORTANT FOR THE SMOOTH RUNNING OF THE COMPANY

2.     LOW GEARED COMPANY WHICH HAS MORE PROPORTIONATE OF EQUITY. THE AMOUNT OF FIXED COST OF CAPITAL BY WAY OF DIVIDEND ON PREFERENCE SHARE CAPITAL AND INTEREST ON DEBENTURES IS LOW AND THE EQUITY SHAREHOLDER WILL GET THE HIGHER RATE OF DIVIDEND

3.     HIGH GEARED COMPANY : WHICH HAS MORE PROPORTION OF DEBT AND PREFERENCE SHARE CAPITAL . FIXED COST OF CAPITAL IS HIGH AND LESS DIVIDEND FOR EQUITY SHAREHOLDERS

• COMPARISON WITH THE AUTOMOBILE GEARS OF AUTOMOBILE

1. THE PURPOSE OF THE GEARS IS TO MAINTAIN DESIRED SPEED AND CONTROL
2. IN THE BEGINNING AN AUTOMOBILE STARTS WITH A LOW GEAR BUT AS SOON IT GETS MOMENTUM THE LOW GEAR IS CHANGED TO HIGH GEAR TO GET BETTER SPEED
3. IN THE SAME WAY INITIALLY A COMPANY MAY HAVE MORE PROPORTION OF EQUITY THAT IS LOW GEAR BUT AFTER MOMENTUM IT MAY BE CHANGED TO HIGH GEAR BY MIXING MORE OF FIXED INTEREST BEARING SECURITIES SUCH AS PREFERENCE SHARE CAPITAL
4. CAPITAL GEARING ALSO AFFECTS DEBENTURE HOLDERS,CREDITORS,FINANCIAL INSTITUTIONS AND FINANCIAL MANAGERS

• CAPITAL GEARING AND TRADE CYCLES
• DURING INFLATION OR BOOM PERIOD:-

1. POLICY OF HIGH GEAR DURING INFLATION
2. AS THE PROFITS ARE HIGH AND EASY TO PAY FIXED COSTS
3. CAN INCREASE THE EARNING PER SHARES AND HIGH RATE OF DIVIDEND

·         DURING DEFLATION OR DEPRESSION:-

1. POLICY OF LOW GEAR
2. RATE OF EARNING IS LOWER THAN THE RATE OF INTEREST/DIVIDEND ON FIXED INTEREST BEARING SECURITIES