What are the advantages and disadvantages of low gearing and high gearing

Capital Gearing and It’s Significance

Definition of Capital Gearing

The most important factor which must be taken into account by the promoters while drafting the financial plan of a company is capital gearing.

Gearing means the ration of different types of securities to total capitalization. The term, when applied to the capital of a company, means the ratio of equity share capital to the total capital and is known as capital gear ratio or capital gearing.

J. Batty defines the term ‘capital gearing’ as “The relation of ordinary shares (equity shares) to preference share capital and loan capital is described as the capital gearing.”

Thus the term capital gearing is used to indicate the relative proportion of fixed cost bearing securities such as preference shares and debentures to the ordinary share capital in the capital structure. Interest of equity share holders is represented by the amount of share capital plus retained earnings and undistributed profits.

High and low Capital Gearing

If the proportion of equity capital to the total capital is small or in other words the ration of other fixed cost capital to total capital is high, it is said to be a state of high gearing of capital. Reverse is the case of low gearing of capital i.e., low proportion of equity capital or high proportion of fixed cost capital to the total capital is an indication of low gearing of capital.

A company with low gearing is one that is mainly being funded or financed by equity capital and reserves, whilst the one with a high gearing is mainly funded by debt capital.

Significance of Capital Gearing

A proper capital gearing is very important for the smooth running of the enterprise. It affects the profitability of the concern.

In a low geared company, the fixed cost of capital will be lower and the equity shareholders will get a higher profit by way of dividend and in case of high gearing the fixed cost of capital will be higher and the profits to be distributed to the equity shareholders will be lower.

Gearing

What is Gearing

Gearing is a tool that is used by investors and businesses to show how much of the long term finance came from loans and how much came from shareholder funds. It also shows how exposed the firm is to financial risk. To see this we can look at the Gearing formula.

Gearing Ratio

The Gearing Ratio looks at the level of borrowing that a company has taken on in the form of loans and compares that to the total long term finance that a business has.

Long Term Liabilities: this figure is how much loans the business has.

Capital Employed: this is the total level of finance that a business has in the long term. It can be shown as the Shareholder funds + Long term liabilities.

As a ratio, we obtain a percentage figure from the formula. Since the formula shows the ratio of Loans to (shareholder funds + Loans), the percentage obtained tells us a few things.

What Does the Gearing Figure mean for the Business and Shareholders?

Gearing shows a firms exposure to financial risk. A high gearing percentage tells us that the firm has a high level of loans compared to shareholder funds. The high level of loans also means that the firm has to pay a higher interest charge. This means that if profits were low, or did not meet predicted levels then the firm would have a tough time paying off the interest charges, which would affect other areas of the firm e.g. a lower investment into Research & Development for a year. So the greater the gearing percentage the greater the exposure to risk, and the risk of interest rate rises.

For shareholders and potential investors the gearing level is important, and as such it is a very important tool when analysing whether a business is a viable investment:

Advantages and Disadvantages of High Gearing

Here are some Advantages and Disadvantages of High Gearing

What Is a Good or Bad Gearing Ratio?

Marcus Reeves is a writer, publisher, and journalist whose business and pop culture writings have appeared in several prominent publications, including The New York Times, The Washington Post, Rolling Stone, and the San Francisco Chronicle. He is an adjunct instructor of writing at New York University.

A gearing ratio is a general classification describing a financial ratio that compares some form of owner equity (or capital) to funds borrowed by the company. Gearing is a measurement of a company’s financial leverage, and the gearing ratio is one of the most popular methods of evaluating a company’s financial fitness.

Key Takeaways

Gearing Ratio

Though there are several variations, the most common ratio measures how much a company is funded by debt versus how much is financed by equity, often called the net gearing ratio. A high gearing ratio means the company has a larger proportion of debt versus equity. Conversely, a low gearing ratio means the company has a small proportion of debt versus equity.

Capital gearing is a British term that refers to the amount of debt a company has relative to its equity. In the United States, capital gearing is known as financial leverage and is synonymous with the net gearing ratio.

What Is A Good Gearing Ratio?

How to Calculate the Net Gearing Ratio

The net gearing ratio is calculated by:

Net gearing can also be calculated by dividing the total debt by the total shareholders’ equity. The ratio, expressed as a percentage, reflects the amount of existing equity that would be required to pay off all outstanding debts.

Good and Bad Gearing Ratios

An optimal gearing ratio is primarily determined by the individual company relative to other companies within the same industry. However, here are a few basic guidelines for good and bad gearing ratios:

What Does the Gearing Ratio Say About Risk?

The gearing ratio is an indicator of the financial risk associated with a company. If a company has too much debt, it can fall into financial distress.

A high gearing ratio shows a high proportion of debt to equity, while a low gearing ratio shows the opposite. Capital that comes from creditors is riskier than the money that comes from the company’s owners since creditors still have to be paid back regardless of whether the business is generating income. Both lenders and investors scrutinize a company’s gearing ratios because they reflect the levels of risk involved with the company. A company with too much debt might be at risk of default or bankruptcy especially if the loans have variable interest rates and there’s a sudden jump in rates.

However, debt financing, or the use of leverage, is not necessarily a red flag. If invested properly, debt can help a company expand its operations, add new products and services, and ultimately boost profits. Conversely, a company that never borrows might be missing out on an opportunity to grow their business by not taking advantage of a cheap form of financing, if interest rates are low.

It’s important to compare a company’s gearing ratio to companies in the same industry. Companies that are capital intensive or have a lot of fixed assets, like industrials, are likely to have more debt versus companies with fewer fixed assets.

For example, utilities would typically have a high gearing ratio but might be considered acceptable since it’s a regulated industry. Utilities have a monopoly in their market-making their debt less risky than a company with the same debt levels, which operates in a competitive market.

Bottom Line

Typically, a low gearing ratio means a company is financially stable, but not all debt is bad debt.

It’s essential for companies to manage their debt levels. However, it’s also important that companies put their assets on their balance sheets to work, including using debt to boost earnings and profits for their shareholders.

A safe gearing ratio can vary from company to company and is largely determined by how a company’s debt is managed and how well the company is performing. Many factors should be considered when analyzing gearing ratios such as earnings growth, market share, and the cash flow of the company.

It’s also worth considering that well-established companies might be able to pay off their debt by issuing equity if needed. In other words, having debt on their balance sheet might be a strategic business decision since it might mean less equity financing. Fewer shares outstanding can result in less share dilution and potentially lead to an elevated stock price.

3 Accounts and finance

Table of Contents

Gearing AO2, AO4

AO2 You need to be able to: Demonstrate application and analysis of knowledge and understanding Command Terms: These terms require students to use their knowledge and skills to break down ideas into simpler parts and to see how the parts relate: Analyse, Apply, Comment, Demonstrate, Distinguish, Explain, Interpret, Suggest

AO4 You need to be able to Demonstrate a variety of appropriate skills. Command Terms These terms require you to demonstrate the selection and use of subject-specific skills and techniques: Annotate, Calculate, Complete, Construct, Determine, Draw, Identify, Label, Plot, Prepare

Once businesses are operating they have two main sources of money for investment to grow the firm:

Most firms operate using a mixture of borrowed capital and their own finance. There are advantages and disadvantages to both sources.

Share capital and retained profits are free of fixed charges; only dividends need to be paid. However, this form of capital may be limited. Relying on it alone may slow growth.

Loans, however, cost a company money in interest payments, but a lack of loans can stifle growth.

The balance between loans and share capital is important. This leads to the concept of the gearing of a business.

Gearing

Gearing measures the proportion of capital employed that is provided by long-term lenders.

Which develops further into the gearing ratio.

Gearing ratio

This is sometimes known as the debt equity ratio.

where capital employed = loan capital (or long-term liabilities)+ share capital+retained profit (IB Syllabus)

What is loan capital? All monies that have been borrowed and interest has to be paid. It will include long-term bank loans, debentures, overdrafts etc. It does not include debtors or creditors; they are interest free.

The gearing ratio value can vary between 0 and 100%. What do individual results mean?

A firm is said to be highly geared if the gearing ratio is over 50%; in other words loans represent more than 50% of capital employed. The higher the gearing ratio: the higher the degree of risk. A lower geared company offers a lower risk investment and as a result they can normally negotiate additional loans more easily and at a lower interest rate than highly geared company.

Improving the ratio AO3

AO3 You need to be able to: Demonstrate synthesis and evaluation. Command terms these terms require you to rearrange component ideas into a new whole and make judgments based on evidence or a set of criteria. Compare, Compare and contrast, Contrast, Discuss, Evaluate, Examine, Justify, Recommend, To what extent

Remember, gearing is a symptom: so changing it in its own right has little value. Obviously, its improvement will depend whether it is currently too high or too low.

Too low: The firm could borrow more money provided there is a suitable investment. Is the real problem behind the low gearing ratio a lack of research or product ideas?

Too high: the firm should attempt to pay off some loans, or raise more share capital. Perhaps the firm is trying to expand too fast.

The gearing ratio of a business will change with time, usually on a regular cyclical basis. It will grow as it invests to expand, and then fall as the retained profits increase as a result of the growth. It will then grow again as the process is repeated with new products etc.

Sources of finance

Sources of finance for a firm will be of one of two types, those that change gearing and those that do not. Some sources will increase gearing; others will reduce it.

1. Methods that change gearing

a) Those that increase gearing:

b) Those that decrease gearing:

Follow the link below to see an example of a rights issue.

2. Methods that do not change gearing

Follow the link below to see an example of sale and leaseback.

Supermarket expansion- sale and leaseback example

Notice that when a business raises more finance, how it achieves this increase will change its gearing. Remember the following:

The implications for gearing must be considered when deciding how to finance an expansion.

Limitations of gearing

As always a series of ratios is required to analyse the situation of the firm fully, plus knowledge of its history. It is very important to know why the ratio has changed.

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What are the advantages and disadvantages of gear reduction?

What are the advantages and disadvantages of gear reduction?

Post by onloop » Jun 21 2014 3:03am

If i want to minimize the stress/load on a DC brushless motor, Can this be achieved using gearing reduction?

Say I have a fairly low 150 KV motor with gearing ratio of 2:1 (15T drive-30T driven)

Re: What are the advantages and disadvantages of gear reduct

Post by ARod1993 » Jun 21 2014 5:10am

The short answer is yes, you can reduce the load on a motor by gearing it down. Basically, the KV of a brushless motor is calculated as the reciprocal of the motor’s torque constant, given in Nm per amp of current; a motor with KV 150 requires 150 amps through the windings (more or less) to put out a torque of 1 Nm at the shaft; gearing down the motor output (at the cost of speed) will magnify the motor torque at the wheel, and therefore producing the same torque at the wheel requires a lower current through the motor windings. You can use this knowledge to define the concept of «KV at the wheel,» or the speed and torque of the driven wheel given a set voltage and current through the motor windings; generally, the system with the lower KV at the wheel will require less current to achieve a given amount of torque, but will also require a higher voltage to achieve the same top speed.

Given your examples, a 150 KV motor geared down 2:1 at the wheel will give your longboard 75KV at the wheel; that means that to produce a full Newton-meter of torque at the driven wheel will require you to put 75 amps through the motor.That torque might be overkill for a longboard; I have no idea because I’m more of a scooter and bike guy, so my systems tend to be between 10 and 40 KV at the wheel). By contrast, the 300KV motor geared down 3:1 has a rating of 100KV at the wheel, and so getting that same Newton-meter of torque will require pushing 100 amps through the motor (25% more current), but you’ll be able to go 25 percent faster at the same voltage with this system than you will with the 150KV system. As far as your questions are concerned:

1) Most likely not; a 300KV motor is likely to be a lot smaller in construction and less powerful electrically than a 150KV motor. It might be seeing 50% less of the overall load than the 150KV motor, but the 150KV motor is most likely far better equipped to handle it (and will need half the current to push the same load as the 300KV motor). If you want to use a small, high KV motor you’re going to have to gear it down pretty far to make this work; see the saga of eNanoHerpyBike for a treatment of this phenomenon; namely, if you gear down a high-KV motor by a lot but not enough you’re going to have an unrealistically high KV at the wheel, giving you an unreachable top speed and fairly little usable launching torque.

In the case of eNanoHerpyBike, Charles used an 880KV motor with an 8.5:1 gear reduction, giving him 103.5KV at the wheel. Given that this was on decent-sized 8-inch pneumatic wheels, that gave him a top speed just north of 60mph, but no launching torque and a huge propensity to burn power heating up the windings; since he was using a «200A» airplane ESC under forced-air cooling with this, it lasted only a little while before the controller blew up. By contrast, the 500KV helicopter motor he put in after blowing the controller gave him about 60KV at the wheel, which meant a top speed of 30mph or so and a fairly scary amount of launch torque.

I think that covers most of my answers to (2) and (3) as well, so onto (4):

Yes. A big motor running at a high voltage through a high gear reduction is going to draw less current and, in general, be decidedly happier as long as you don’t exceed the breakdown voltage of (or otherwise damage or melt) the wire insulation or something like that. You’re better off taking a slightly lower top speed (or running a slightly higher voltage) on your vehicle and being able to haul ass without drawing a ton of current than you are doing the inverse.