gearing

Question 1

what is gearing

Answer 1

what % of the businesses capital comes from borrowing
-lowly geared- borrowed less than 1/4 than total capital employed into organisation (0-24%)
-moderately geared- businesses strive for this, 1/4- 1/2 of capitol employed comes from borrowing (25%-50%)
-highly geared- more than half of capital employed is funded from borrowing

Question 2

what are the consequences of being highly geared

Answer 2

-having to pay back loans with the addition of interest
-makes highly geared businesses vulnerable to changes in interest rates
-rises in interest rates even if small can have significant increases on the amount of money paid back monthly
-therefore impact the liquidity of the organisation
-if the business can managed being highly geared by servicing debts regularly and not experiencing liquidity problems

Question 3

consequences of being lowly geared

Answer 3

-not a big reliance on borrowing to able to absorb the impacts of rising interest rates
-other percentages of capital employed coming from other sources such as shareholders and retained profits, organic funding- retained profits restrict profits from shareholders (owners of the organisation) - can lead to unsatisfied short term investors, long term may find it plausible
-usually in a stronger position as not at risk of changing interest rates

Question 4

why is being moderately geared appealing

Answer 4

-attractive for business owners as it satisfies shareholders and owners while reducing the risk of being vulnerable to changes in interest rates. -not jeprodisring the liability and viability and liquidity of the organisation

Question 5

How may a highly geared business reduce its gearing

Answer 5

-usually occurs when worried if the risk attached
-payback of long term borrowing- sucks cash out of the business which may be impactful in the short term
-increase the amount of kept retained profits so that they can fund capital employed organically - different responses from shareholders
-issuing more shares- issues with control and governance of the business

Question 6

what is the gearing formulae

Answer 6

long term liabilities / capital employed
x100

Question 7

capital employed calc

Answer 7

total equity + non current liabilities