Q. Show danger of high financial gearing?
A additional danger of high financial gearing is that a company may move into a loss-making position as a result of high interest payments. It will thus become difficult to raise additional finance, whether debt or equity and the company may require undertaking a capital reconstruction.
It is probable that a business with high operational gearing will have low financial gearing and a business with high financial gearing will have low operational gearing. This is for the reason that managers will be concerned to avoid excessive levels of total risk that is the sum of business risk and financial risk. A business with a grouping of high operational gearing and high financial gearing clearly runs an increased risk of experiencing liquidity problems making losses and becoming insolvent.