ratio analysis Flashcards
debt
finance provided externally i.e. bankloan
equity
amount invested by owners of the business i.e. share capital or retained profits
reasons for higher equity
greater risk
more flexibility required
reasons for high level of debt
where interest rates are low so debt is cheap
debt can be repaid easily with strong cash flow
gearing ratio
non current liabilities/ total equity+ non current liabilities x100
what level of gearing ratio is considered high
50%+
what level of gearing ratio is considered low
less than 20%
what is gearing ratio dependant on
type of business, situation and industry
benefits of high gearing
less capital needs to be invested by shareholders
debt can be relatively cheap compared to dividends
business has capacity to add more debt
benefits of low gearing
less risk of defaulting on debts (being unable to pay back)
shareholders have ability to make decisions rather than debt providers
capacity to add more debt
what is ROCE
a calculation used to evaluate overall business performance
provide a target return for individual projects
compare performance with competitors
ROCE
operating profit/ capital employed x100
capital employed
total equity add non current liabilties
how could levels of ROCE vary
between industries as service sector usually has less capital employed than a manufacturer
how can ROCE be unreliable
based on a snapshot of business’ balance sheets
