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Why is capital gearing ratio important to business financing?

 

Business financing: Capital gearing.


This article first appeared on Ayi Post.


1. What is capital gearing?


2. Why is capital gearing ratio important to business?




3. Why is capital gearing ratio important to business financing?


Having a great business idea without a startup capital is like wandering a vast desert in search of an oasis. 


You are literally going to leap in when you see one. Then gulp down the water with all the impurities.


It’s wise to understand what capital gearing is before you decide to borrow or not to borrow to start your business.


What is capital gearing?


It’s a financial ratio that shows the amount of debt of a company to it’s equity. It’s a measure of financial risk. 


This risk increases toward volatility as the ratio of debt to equity gets higher.



The higher the gearing ratio, the more the interest payable on debt and the lower the earnings on equity. You may end up borrowing to service debt commitments.



The risk doesn’t end with sinking deeper into more debts, your control of the company could also be threatened.



Your creditors may want to teach you best ways to run your business profitably. 



This may come in the form of business partnership and so called, “business support”. In most cases, their way will not be on the same level with your vision.



Before you look to lenders for funding, have an amount of equity that would guarantee a lower capital gearing. 



Your capital gearing should be a ratio that keeps with you, the control and the freedom to be proactive and react quickly to evolving trends.



Only borrow when you’re certain you will have a positive leverage. 



That is, only when projections indicate that your earnings from the application of debt are going to be greater than interest payable on debt.



But should you even borrow to start a business? 



The answer is Yes. Debt financing is not a bad idea if you’ve sincerely mastered strategies that guarantee favorable returns on intended investment.



You must also be ready to work hard and proceed as if you were bootstrapping.



As a takeaway, keep the gearing ratio lower than 25 percent.



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