Answer :
Debt is a common financial concept that involves borrowing money to be paid back at a later date, typically with interest. It's crucial when understanding personal finance or corporate financial strategies. Let's explore the two aspects mentioned: positive and negative debt, as well as gearing.
10.1 Positive and Negative Debt
Positive Debt: This refers to borrowing that is used to improve financial well-being in the long run. For example, student loans used to acquire education can be considered positive debt because education can lead to better job opportunities and higher income. Mortgages for real estate can also be positive if the property appreciates over time.
Negative Debt: This type usually involves borrowing for things that do not generate income or increase in value. For instance, using a credit card for daily expenses that can't be paid off fully each month. The interest accumulates quickly, making this debt more costly over time. Similarly, taking loans for depreciating assets like cars can create negative debt if the vehicle loses value faster than the loan is paid off.
Understanding whether debt is positive or negative involves considering the purpose of the debt and its long-term financial impact.
10.2 Gearing
Gearing refers to the financial ratio that compares an entity’s borrowed funds to its equity. It essentially measures the degree to which a company's operations are funded by debt versus its own capital. High gearing means a high proportion of debt to equity, while low gearing indicates the opposite.
High Gearing: Companies with high gearing levels may benefit from tax advantages because interest expenses are tax-deductible. However, they are also more vulnerable to economic downturns as they have significant debt obligations.
Low Gearing: This indicates that a company is less reliant on borrowed funds, potentially suggesting more financial stability. However, it might also imply that the company is not taking advantage of potential growth opportunities that borrowing can fund.
Gearing is a critical consideration for investors and managers, as it affects both risk and return profiles of investments and operations.
