Enterprise: Strand 2 5. Gearing Capital is the money a company starts with. It can be divided into debt capital and equity capital.


Debt capital is a long-term source of finance on which interest is paid. It is also known as a debenture. Interest is at a fixed rate. An example is a long-term loan.


The company also has shares that they sell. The total shares sold is known as ordinary share capital. This is called equity capital.


The relationship between equity capital (ordinary shares) and debt capital (debentures) is called gearing.


Example 1


A company has a loan of €200,00 at a rate of interest of 10%. It is to be repaid by 2023. It has ordinary share capital of €50,000. Calculate the gearing.


Solution Formula


Debt : equity ratio Debt capital : equity capital


Example


€200,000 : €50,000 4:1


Examination tips


1. Know the formula. 2. Use your calculator. 3. Show your workings. 4. Answer = x:x


Think IT! Question: Is the gearing position good?


Answer: No, this business has debt capital four times its equity. It is relying on borrowed money more than money from shareholders.


Know It!


Highly geared: more debt capital than equity capital.


Lowly geared: more equity than debt capital.


Example 2


A company has a loan (debt capital) of €100,000 at 15% interest to be repaid by 2023. It has ordinary share capital of €500,000. Calculate the gearing.


Debt : equity ratio Debt capital : equity capital


€100,000 : €500,000 .20 : 1


This business is low geared – its debt capital is .20 its equity. It is relying on shareholders’ money more than borrowed money.


So it’s good to have less debt capital.


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