Gearing Ratios

Question 1

Gearing Ratio Formula

Answer 1

Gearing ratio (%)= (non-current liabilities / capital employed) x 100

Question 2

Gearing ratio

Answer 2

Shows the proportion of a firms finance that’s from non-current liabilities
Focuses on the capital structure of a business
Above 50% is risky (in long term debt)
25%-50% gearing is normal
Under 25% is good
Shows how vulnerable a business is to interest rates

Question 3

Gearing ratio below 25%

Answer 3

Most long term funds come from shareholders or reserves
Shows the firm is risk averse- doesn’t run the risk of spending too much money on interest payments
Can withstand a fall of profits more easily and.can reduce dividend payments to shareholders

Question 4

Gearing ratio above 50%

Answer 4

Most long term funds come from borrowing
Firm is willing to take risks
If profits fall or interest rates rise, the business has to keep up with loan pay,ents or could lose assets

Question 5

Advantages of high gearing

Answer 5

Can be risk but may come with rewards
Extra funds for expansion which helps gain a competitive advantage
Attractive during growth phase
During growth there is a lot of profit even after paying off payments

Question 6

Disadvantages of high gearing

Answer 6

May not be able to afford repayments
Taking out loans is risky
The more borrowed, the harder it will be to pay back if interest rates rise