3.5.2 ratio analysis Flashcards
gearing
measures the proportion of a business’ capital provided by debt
uses of gearing ratio
measures the financial health of a business.
focuses on the level of debt in the financial structure of a business
two ways of measuring gearing
debt / equity ratio
gearing ratio
what is the capital structure of a business?
capital of a business represents the finance provided to it to enable it to operate over the long-term
two parts of the capital structure
equity
debt
equity
amounts invested by the owners of the business
share capital
retained profits
debt
finance provided to the business by external parties
bank loans
other log term debt
capital structure objectives
higher equity = greater business risk, more flexibility required
high levels of debt = interest rates are low means debt is cheap
gearing ratio formula
non-current liabilities / capital employed x 100
gearing %
gearing ratio of 50% + = high
gearing ratio of less than 20% = low
benefits of high gearing
less capital required to be invested by the shareholders.
debt can be a relatively cheap source of finance.
easy to pay interest
benefits of low gearing
less risk of defaulting on debts.
shareholders rather than debt provides call the shots.
business has the capacity to add debt if required
roce
return on capital employed
roce uses
evaluate the overall performance of the business.
provide a target return for individual projects.
benchmark performance with competitors
roce formula
operating profit / capital employed x 100
