Gearing

Question 1

Debt to Equity ratio

Answer 1

Borrowed Capital : Own Capital
(Non-Current Liabilities) (Shareholders’ Equity)
•Loans
•Share Capital
•Retained Income

Important:
Use this ratio to comment on loans

0,5:1 to 0,9:1 highly geared
Business will be able to take out additional loans
0,1:1 to 0,4:1 lowly geared

This ratio tests the credit worthiness of the business and indicates the extent to which the business is geared (financed) by loans
Credit providers are the interested parties:
Ø Banks
Ø Creditors High Gearing
Ø Highrisk(disadvantageous)
Ø Loans are high
Ø Costly – interest has to be paid
Low Gearing
Ø Lowrisk(advantageous)
Ø Regardedascreditworthybybanks

Improvement in the ratio can be attributed to:
• Increase in the number of shares issued
• Decrease in loans through partial repayments
How does the ratio compare with the previous year?

Question 2

Return on Total Capital Employed (ROTCE)

Answer 2

Net Profit before Tax + Interest x 100
Average Capital Employed
Answer = X %

Capital employed =
Shareholders’ Equity + Non-current Liabilities

This ratio indicates whether the business has a return on capital employed that is higher or lower than the percentage paid on loans

Important:
Use this ratio to comment on loans Consider the following:
Positive Gearing; (Favourable)
• Applies when funds are borrowed at a relatively low interest rate in order to earn relative higher returns
Negative Gearing: (Unfavourable)
• Applied when funds are borrowed at a relatively
higher interest rate and the difference between return earned on Capital Employed by utilizing borrowed funds is relatively narrowed down
• Example:
Interest on loan=15 % compared against the ROTCE of 22%
• Applies when interest rates on loans are equal to or relatively higher than the return earned by the company Employed
How does the result compare with the previous year?