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Gearing or Leveraging
Gearing, as in the mechanical sense, is the process of turning a small effort into a large output. This can be explained as in a lever or ina a bicycles gears.
In financial terms it has the same effect. There are several types of financial gearing. These are: Investment gearing, financial gearing and operational gearing. The one we are most interested in is investment gearing, but I will explain the other two briefly.
A company can be highly geared or less highly geared. Here we mean the ratio between company debt and equity.. A larger proportion of debt (borrowings) to equity gives high gearing. As the profit goes up the small equity stake takes a lerger share of the profits.
If a company has high fixed costs it would be said to have high operational gearing. If the production went up the fixed costs, remaining the same would become less as a ratio to the profit. This could be a company with expensive machinery and low man-power, as opposed to a company with little mecahnisation but high demand of labour (labour intensive).
This is the ability to use a small investment to gain control over a larger investment. One method is to use an option. You could buy £10000 of a company share or you could pay £1000 for an option to buy £10000 worth of shares for , say, three months. If the shares double to £20000 the outright purchase makes a profit of £10000 or 100% profit. The option, however, still makes £10000 but on the stake of £1000 the profit, as a percentage is 1000%