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Capital structure

Financial gearing

Financial gearing is a measure of the extent to which debt is used in the
capital structure.

Note that preference shares are usually treated as debt.

Financial gearing can be measured as equity gearing, capital gearing or interest
gearing:

Debt Debt Debt interest

––––– or ––––––––– or ––––––––––––––––––––––––––––––––––
Equity Total capital Operating profit before debt interest and tax

And can be calculated using book values or market values.

If using book values, remember to include reserves in the value of equity.

Where two companies have the same level of variability in earnings, the
company with the higher level of financial gearing will have increased
variability of returns to shareholders.

Hence an increase in gearing represents an increase in risk for the equity investor.

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