Q. Define about financial gearing?
As financial gearing raise the burden of interest payments increases and earnings become more volatile. Since interest payments should be met shareholders may be faced with a reduction in dividends at very high levels of gearing a company may cease to pay dividends altogether as it struggles to find the cash to meet interest payments.
The pressure to meet interest payments at high levels of gearing is able to lead to a liquidity crisis where the company experiences difficulty in meeting operating liabilities as they fall due. In severe cases liquidation may take place. The focus on meeting interest payments at high levels of financial gearing is able to cause managers to lose sight of the primary objective of maximizing shareholder wealth. Their major objective becomes survival and their decisions become focused on this rather than on the longer-term prosperity of the company. Essential investment in fixed asset renewal may be deferred or neglected.