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Operational Gearing: The Impact of Borrowed Money on Trading ProfitOperational gearing is a ratio that is designed to measure how sensitive profits are to sales revenue / turnover. It measures change as a percentage and specifically, the change in trading profit which comes from a one percent change in sales revenue. Obviously, this also depends on the relationship between fixed and variable costs and profits. Fixed costs are those that are incurred regardless of sales revenue and are also known as indirect costs. Variable costs are directly reated to sales revenue and are therefore often called direct costs. Operational gearing = (Sales Revenue - Variable Costs) : Trading profit or Operational gearing = (Trading profit + Fixed Costs) : Trading profit This ratio means that the borrowed money acts as a multiplier. If performance increases, it will be magnified and results enhanced further. However, this means that the opposite is also true. If results deteriorate, the borrowed money will act as a weight and drag performance down even further. In other words, borrowed money will either add an extra lever - or mutliplier - to profits. Depending upon trading performance, interest rates and the state of the economy, this can be either a good or a bad thing! Other fundamental analysis related pages include:
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