Capital Gearing Ratio is a kind of solvency ratio that determines the ratio of fixed return capital to ordinary return capital/share capital.
$$Capital\quad Gearing\quad Ratio=$$$$\frac { Fixed\quad Interest\quad Funds }{ Common\quad Shareholder’s\quad Equity }$$Where,
$$Capital\quad Gearing\quad Ratio=$$$$\frac { Fixed\quad Interest\quad Funds }{ Common\quad Shareholder’s\quad Equity }$$Where,
- Fixed Interest Funds include Preference Shares, Bonds, and Debts (Current as well as Long Term) that include a fixed rate of interest.
- And Common Shareholder’s Equity includes Share Capital, Reserves and Surplus, Money received against Shares and Warrants that do not have any fixed rate of interest.
Significance and Interpretation
- Capital Gearing Ratio = 1: This implies that the Common Shareholder’s Equity is just equal to the Fixed Interest Funds which is an alarming and high-risk situation for a company. The total outgo in the form of fixed interest will be high.
- Capital Gearing Ratio < 1: The company will be considered safe if the Capital Gearing Ratio will be less than 1, as less the Capital Gearing Ratio more stable and solvent the company is.
- Capital Gearing Ratio > 1: The company is categorized as a high-risk company and on the verge of being insolvent. Creditors do not want to invest in a company with High Capital Gearing Ratio.
- The ideal Capital Gearing Ratio is less than 0.25, however, values up to 0.50 can be considered safe. However, it must be noted that this limit may shift depending upon the regulatory reforms and/or type of business.
Examples
Example 1:
Consider the following details of M/S ABC ltd. and find out its Capital Gearing Ratio.| Particulars | Amount (in ₹ Cr) |
|---|---|
| Share Capital | 1500.00 |
| Reserves and Surplus | 300.00 |
| Preference Shares @10% | 250.00 |
| Bonds @8% | 300.00 |
| Short Term Debt @12% | 250.00 |
| Long term Debt @10% | 220.00 |
Solution:
Fixed Interest Funds = Preference Shares + Bonds + Short Term Debt + Long Term Debt
⇨ (250 + 300 + 250 + 220)
⇨ (250 + 300 + 250 + 220)
⇨ ₹ 1020.00 Crores
Common Shareholder’s Equity = Share Capital + Reserves and Surplus
⇨ (1500 + 300)
Common Shareholder’s Equity = Share Capital + Reserves and Surplus
⇨ (1500 + 300)
⇨ ₹1800 Crores
Capital Gearing Ratio = Fixed Interest Funds / Common Shareholder’s Equity
Capital Gearing Ratio = Fixed Interest Funds / Common Shareholder’s Equity
⇨ 1020/1800
Hence, Capital Gearing Ratio = 17/30 or 0.567
Hence, Capital Gearing Ratio = 17/30 or 0.567
