3.5.2 Ratio Analysis

Question 1

What is the Gearing Ratio?

Answer 1

Gearing focuses on the capital structure of the business
-that means the proportion of finance that is provided by debt relative to the finance provided by equity (or shareholders).

Question 2

What is equity?

Answer 2

This is the money invested into the business by the owners

Question 3

What is a debt?

Answer 3

Finance borrowed from external sources such as:

1. Bank loans
2. Mortgage
3. Leasing

Question 4

What is the formula for Gearing Ratio?

Answer 4

Long term liabilities \ Total capital in the business

(Total equity + non-current liabilities) x100

Question 5

What Gearing ratio is good?

Answer 5

Less than 25% is good
25% to 50% is normal for well established business
50% and above is very risky

Question 6

Benefits of high gearing

Answer 6

Shareholders do not have to invest as much share capital

Interest rates are low so the cost of borrowing may be outweighed by the rewards of what the finance can be used for

Question 7

Benefits of low gearing

Answer 7

Less repayments to make to lenders.

Question 8

What is return on capital employed?

Answer 8

ROCE tells us what returns (profits) the business has made on the resources available to it.

Operating profit \ Capital employed x100

Question 9

What is the formula for Capital employed

Answer 9

Share capital + Retained Earnings + Long-term liabilities

Question 10

Evaluating ROCE

Answer 10

1. Higher % is better
2. Watch is for trend over time
3. Watch for trend over time
4. Leased equipment will not be included in capital employed