3.5 - Assessing competitiveness Flashcards
Give and describe the gearing ratio
Non-current Liabilities / Capital Employed x 100
Capital employed = total assets - current liabilities
Capital employed = total equity - current liabilities
Capital Employed = Shareholders’ Equity + Non-Current Liabilities
- Shows how much investment in a business if financed by long term borrowing (non-current liabilities)
- The gearing ratio shows the long-term financial structure of the business
- It shows the balance of non-current liabilities (e.g. long-term loans) to shareholder capital used to fund a business
Give the formula for Return on Capital Employed
Operating profit / Capital employed x 100
Capital employed = total assets - current liabilities
* Higher = better
- It compares the profit made by a business to the amount of capital invested in the business
- It is a measure how how effectively a business uses the capital invested in the business to generate profit
Breifly describe methods of increasing the gearing rate
A low-geared business may take steps to increase its ratio by:
* Buying back ordinary shares to reduce share capital in relation to borrowing
* Issue more preference shares with limited loss of control
* Obtain more loans
Breifly describe methods of reducing the gearing rate
A highly-geared business may take steps to lower its ratio by:
- Issuing more ordinary shares to create further share capital
- Retaining more profits to avoid further borrowing
- Repaying loans to lower interest costs for the business
Describe a highly geared business
Highly geared business
* In a highly-geared business more than 50 per cent of its capital employed are long-term loans
* The outcome of the gearing ratio calculation will be greater than 50 per cent
* Substantial levels of interest will need to be paid on this high level of borrowing which means the level of profit available to pay as dividends to shareholders is reduced
* Profit available to retain within the business is limited
* The business is likely to be considered a risk for further investment - likely to face difficulties in raising further loan capital
Low geared business
* A low-geared business has less than 50 per cent of its capital employed as long-term loans
Describe a low geared business
Low geared business
* A low-geared business has less than 50 per cent of its capital employed as long-term loans
* The business may be missing out on the opportunity to access finance without the need to dilute existing shareholders’ control
* This is especially true when interest rates are very low as has been the case in the UK over the last 15 years
* Lenders such as banks are more likely to approve loan applications from low-geared businesses
* An unwillingness to access loan capital may indicate a risk-averse business which may deter investors
* Low-greared business may use more retained profit to fund capital employed and thus pay less to shareholders, potentially making it harder to raise share capital in future
Describe how to interpret Return on Capital Employed (RoCE)
Interpreting Return on Capital Employed (RoCE)
* RoCE measures how well a business generates profit from the funds invested in the business
* With RoCE the higher the rate, the better, as it indicates that the business is profitable and using its capital efficiently
* Investors prefer businesses with stable and rising levels of RoCE, as this indicates low-risk growth is being achieved
* A ROCE of at least 20 per cent is usually a good sign that the company is in a good financial position
* The rate differs between industries so comparison across sectors is not recommended
* However, it can be compared with other forms of return, such as interest rates on savings, previous years RoCE, close competition
* RoCE can be used to support strategic decisions (e.g. investment or divestment decisions) to determine the most profitable option given the level of capital employed
* To increase the RoCE level a business can
* increase the level of profit generated without introducing new capital into the business
* maintain the level of profit generated whilst reducing the amount of capital in the business
What is capital employed (give formula)?
- Capital employed = Total equity + non-current liabilities
- Total equity = total assets - total liabilities
- Capital employed = Share capital + Retained Earnings + Long-term borrowings
Some sources say capital employed is equal to net assets
What is meant by shareholders equity?
Shareholder equity (SE) is a company’s net assets and it is equal to the total monetaty amount that would be returned to the shareholders if the company must be liquidated and all its debts are paid off. Thus, shareholder equity is equal to a company’s total assets minus its total liabilities.
Labour Productivity formula
Total output / no. of workers
Labour turnover formula
Within a set time period:
number of employees leaving / average number of employees X 100
Absenteeism formula
Within a set time period:
Number of work days lost through absence / total possible days worked X100
