unit 7 Flashcards
gearing
what proportion of its finance comes from the non-current liabilities (long-term debt) rather than share capital or reserves (equity)
gearing %
non current liabilities / total equity + non current liabilities x 100
what does gearing show
how vulnerable a business is to changes in interest rates
more a business is borrowing, the harder they will be hit by interst rates
what can gearing show to an investor
it is a risk assesment that can be used to help decide whether to buy shares in the company, the more the firm borrows the more interest it will have to pay and this may affect profits and the dividend paid to shareholders
advantages of high gearing
extra funds for expansion
can be attractive during growth phase
when interest rates are low high gearing is less risky because interest payments lower
why is high gearing attractive during growth phase
firm trying to become market leader with growing profits and strong product portfolio may borrow heavily in order to fund expansion and gain comeptitive advantage
risks of high gearing
may not be able to afford repayments
might not make enough profit to pay back loan and interest
taking out loans can be risky when interest rates are low because they may go up later and bs will still be committed to making repayments
advantages of ratio analysis
can be used to spot trends and to identify financial strengths and weaknesses of the business
however these trends need to take account variable factors (inflation, business activities, market environment)
can help with decision making
can help potential investors decide to invest
useful to compare with other bs
limitations of ratio analysis
internal strengths such as quality of staff do not appear in figures so won’t show up in rations
figures do not reflect external factors
figures cannot predict future changes such as tech advances or changes in interest rates
rations only contain info about past or present , new bs will not find use
