Financial Terms Glossary

Gearing

Formal

Companies raise both Equity (Share Capital) and Loans (interest bearing) in the normal course of their business. This term describes the balance and blend of these two very different forms of funding. Loans are interest bearing and this interest must be paid irrespective of the profits of a company. Share Capital has ownership rights - meaning entitlement to a share in the profits, which can only be distributed when profits are made. Too many loans - high gearing, high risk. Too much equity and the right to use cheaper (lower rate) interest loans is lost.

Informal

Companies get long-term money to run their business from two different places. One of these is the bank - which generally requires interest charges for the use of these funds - and the other is through shares, which is a long term, almost permanent commitment to fund a business. The loans carry interest that must be paid no matter what. The shares get dividends, but only when the company is profitable. Gearing is the balance between these two forms of funds - bearing in mind the different levels of returns required and the different circumstances in which they are paid.

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