Accounting - Financial Gearing Flashcards
What are financial Gearing ratio?
Asses the risk to shareholders from excessive borrowing / leverage
Why are Gearing ratios useful?
they consider the capital structure of a company and relationship between 1) borrowing 2) SH funds
What does high gearing often mean??
High levels of financial risk
What are the Gearing ratios?
1) Debt to Equity
2) Net Debt to Equity
3) Interest Cover
4) Asset Cover
What is ratio for Debt to Equity?
Debt to Equity = Interest bearing loans + Preference share capital / SH Equity
What does Debt to Equity measure?
It measures the risk to shareholders of receiving lower funds
Interpretation of Debt to Equity
Higher D2E = Higher Gearing = Higher leverage
Questions from Debt to Equity
1) OVERDRAFTS - is o/d interest bearing loan or not?
2) CONVERTIBLES - how should thy be treated?
What is included in Debt from b/s?
overdraft, secured debt, unsecured debt
What is included in Equity on b/s?
Share capital, share premium, retained earnings and revaluation reserve
What is Net debt to Equity ratio?
Net debt = ( Interest bearing loans + Preference share capital) - cash and current investments / SH Equity
what does Net debt to Equity measure/
Measures the cash and investments which a business can use to offset debt
What is Interest cover ratio?
IC = Op. profit + Interest receivables + other inc receivables / Interest payable
what does Interest cover measure?
Measures the ability for a company to pay fixed interest on borrowings out of operating profit and other income receivables
Interpretation of interest cover:
Higher level of cover = less risk to SH or lender but varies with sector therefore no single optimal level
if too high - could mean the company is not making use of cheap finance
Who uses Asset Cover ratio.
lenders use to examine ratio between loans granted and assets available to repay them - therefore the likelihood of repayment
What is asset cover ratio?
AC = Total assets - Current Liabilities / Loans payable
What is an assumption with AC?
assumption that the true value of assets on b/s is the same as market value which is not always the case therefore not always a reliable indicator
