GEARING RATIOS

Gearing Ratios
Gearing Ratios…read more

Gearing ratio measures a firms dependency on
borrowed money.
· It is concerned with long-term financial position
of the company.
· Gearing = Long Term Loans
Capital Employed x 100 %
Example
Long-term liabilities= £1,200k
Current liabilities = £5,655k
Acid test ratio = 21.2%
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Gearing ratios shows how risky an investment a
company is.
· If loans represent more than 50% of capital
employed the firm is highly geared.
- This means that the firm has borrowed a lot of
money in relation to its total capital.
· A low gearing shows that a firm has raised most
of its capital from shareholders i.e. share capital
& retained profits.
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Low geared companies provide less risk.
· They will be able to negotiate loans more
easily at lower costs
· Banks will be more reluctant to lend to a
firm with high gearing ratio.
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Raising Gearing Reducing Gearing
· Issue more · Issue more ordinary
debentures shares
· Get more loans · Repay loans
· Buy back ordinary · Retain more profits
shares
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A profitable firm will prefer high gearing as
its dividends will be more than the interest
on the loan.
· Firm can benefit from cheap source of
finance if interest rates are low
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