Gearing Flashcards
What ratios are included with gearing?
- Gearing
- Interest cover
What is gearing concerned with?
-Concentrates on the long-term liabilities of the business and its ability to borrow money, and its ability to cover the cost of borrowing.
What type of ratio is gearing?
Solvency ratio.
What is gearing?
This type of ratio considers the level of risk for a business.
- It measures the level of risk by comparing the levels of debt and the amount of equity (capital employed) within the business; the proportion of the business that is financed through long-term borrowing.
- It is the percentage of long-term finance that is made up from loans, rather than shareholders’ funds and retained profits.
At what percentage is the gearing ratio deemed to be high and low?
It is deemed to be high if the long-term borrowing (non-current liabilities) is more than 50% of the capital employed (total equity) and low if below 50%.
Why is it bad for the business to be highly geared?
If the proportion of borrowing (debt) is high, there is more interest to pay, and any fall in sales revenue and subsequently profit will make it harder for the business to finance this borrowing.
-The higher the proportion of assets financed through long-term borrowing, the greater the risk for the business.
Why is being highly geared for businesses when looking for potential lenders?
Highly geared (high proportion of debt) means potential lenders, like banks, are less likely to be willing to make further lending; business is at greater risk of not bing able to meet the interest charges and therefore the risk may be too high.
What does a high proportion of capital being borrowed mean when trying to get an additional loan?
If a high proportion of the capital within the business is borrowed, the business owns less capital to use as security on any additional loans.
