Financial risk from gearing
Debt holders have contractual claims that take priority over residual ordinary-shareholder returns. As a result, operating-profit changes can produce larger proportional changes in earnings available to equity. This is the technical financial-risk meaning used when distinguishing business and financial risk in capital-structure analysis. 'Financial risk' is also a broader umbrella for market, credit and liquidity exposures in other contexts; the glossary must identify the intended sense. Gearing can create tax benefits but also increases distress exposure and the return required by shareholders.
Worked example
Operating profit falls from $200,000 to $100,000, a 50% reduction. With fixed interest of $60,000 and ignoring tax, earnings available to equity fall from $140,000 to $40,000, a 71.43% reduction. Debt amplifies the equity effect.
Common mistake
Confusing the specific gearing-related meaning with every possible financial-market risk, or assuming debt changes the underlying product demand itself.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | AFM | Supporting | September 2026–June 2027 |
| ACCA | FM | Direct | September 2026–June 2027 |