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Financial Gearing affects the Profits of the Company because the debt borrowing increases interest payments which will eventually result in decrease in Profit after Tax so shareholders will be unhappy because now they are left with the lower PAT so lower dividend will be paid?
Operating Gearing is where there is higher Fixed costs which results in reduction in Profits of the Company due to changes in Sales Volume?
Operating Gearing is calculated as : Contribution / PBIT
Since u said in the lecture that there is no standard ratio to calculate operating gearing but we can use this then!?
Thanks! 🙂
The effect of both types of gearing is not that profits are reduced but that the amount available for shareholders becomes more risky due to the fixed payments, as I illustrate with examples in my lectures.
And yes, you can use contribution/PBIT as a measure of operating gearing.
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