Gearing

Gearing (leverage) is a measure of the level of debt capital (borrowing/ borrow funds: Bank Loans, Mortgages & Bonds) as a proportion of long term funds/finance used by a business. It is separate into High gearing and Low gearing. High gearing a high level of fixed interest capital debt fiancé (borrowed funds) and a low level of equity (ordinary shares). It is high risk because shareholders have the residual right. and are paid. They can get back the profit or assets after all expenses liabilities It is high return if the company is doing well.

Low gearing a low level of fixed interest capital debt fiancé (borrowed funds) and a high level of equity (ordinary shares). It is low risk because dividends pay out not mandatory and not need to repay equity capital. Low return because don’t have a potential gearing bonus High risk (doing badly) Borrow 5 % Earn -3 % Lose -8 % Example 1: (Debt finance) Operating profit Interest payable Profit before taxation Retained Profit Example 2 Operating profit Interest payable Shareholders left 1,000,000 (500,000) 500,000 300,000 AA Ltd 300,000 (200,000) 100,000 (Equity financed) Operating profit Corporation tax (40%) Profit after taxation dividends Retained profit High return (doing Well) 5% 12% 7%

1,000,000 (400,000) 600,000 (500,000) 100,000

Cooperating tax (40%) (200,000)

AA Ltd (higher profit) Operating profit Interest payable Shareholders left 600,000 (200,000) 400,000

Advantages - If doing good: HRHR- (Debt finance)If doing well: Interest is tax deductible – From the Example1 : AA Ltd interest reduce taxable profits to 200,000 HRHR -(Debt finance) Fixed interest rate, Profit exceeds can be kept by shareholders From the Example2: The profit the ordinary shareholders get 4 times from 100,000 to 400,000 if the business doing well LRLR - (Equity financed) It is not mandatory to pay out dividends, in example 1 If doing well and not pay out dividends: retained profit even higher is 600,000 If doing bad: the company...