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Financial risk can be calculated with the Gearing ratio AND Business risk can be calculated with the Operating Gearing (Contribution / PBIT)
I know that with gearing ratio we are looking for risk of debt borrowing which will affect the company cost of capital but what exactly are we looking for when calculating Operating Gearing?
Is it correct that with Operating gearing we are looking unsystematic risk of the company?
The business risk is the risk of the business itself which is partly due to systematic risk (the effect of general economic factors which depends on the type of business) and unsystematic risk (which is factors specific to the particular business of which the level of operating gearing is one factor).
The financial risk is due to the level of gearing and makes the shares in the company more risky that the risk of the business.
Sir, you did not say whether:
1) Financial risk can be calculated with the Gearing ratio AND Business risk can be calculated with the Operating Gearing (Contribution / PBIT)
2) What exactly are we looking for when calculating Operating Gearing?
3) Is it correct that with Operating gearing we are looking at unsystematic risk of the company?
Thank you! 🙂
I did answer all of those questions!!!!
1. The financial risk is only related to the level of financial gearing. The level of financial gearing makes the shares more risky than they otherwise would be.
2. Operating gearing measures how the operating expenses of the business are split between fixed costs and variable costs (as I explain in my free lectures).
3. The level of operating gearing is one part of the unsystematic risk of a business.
Do read my reply again, and do watch my free lectures.
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