Types Of Ratios

Question 1

What links does gearing ratio have?

Answer 1

Sources of finance
Equity and debt
Business failure
Interest rates
Liquidity

Question 2

Why is gearing useful?

Answer 2

• Measures the financial health of a business
• Focuses on the level of debt in the financial structure of a business
• High gearing can mean high business risk

Question 3

What is the gearing ratio formula?

Answer 3

Gearing % = Non current liabilities/total equity + non current liabilities (also known as capital employed)

Question 4

What does a gearing ratio of 50%+ suggest?

Answer 4

High

Question 5

What is a gearing ratio of 20% suggest?

Answer 5

Low

Question 6

What are the benefits of high gearing?

Answer 6

Less capital required to be invested by shareholders
Debt can be relatively cheap source of finance compared with dividends
Easy to pay interest if profits and cash flows are strong

Question 7

What are gearing ratios?

Answer 7

Gearing” measures the proportion of a business’ capital (finance) provided by debt

Question 8

What are the two ways of measuring gearing?

Answer 8

Debt/equity ratio

Gearing ratio

Question 9

What is equity?

Answer 9

Amounts invested by the owners of the business
E.g Share capital, Retained profits

Question 10

What is debt?

Answer 10

Finance provided to the business by external parties
E.g Bank loans, other long term debt

Question 11

What are the benefits of low gearing?

Answer 11

Less risk of defaulting on debts
Shareholders rather debt providers “call the shots”
Business has the capacity to add debt if required