calculating gearing
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Calculating Gearing. What does gearing measure?. The gearing ratio looks at the relationship between the debts of a firm a nd other forms of capital. Money to pay for a firms assets can come from shareholders, profit retained by a business, or money borrowed from lenders - PowerPoint PPT PresentationTRANSCRIPT
Calculating Gearing
What does gearing measure?
The gearing ratio looks at the relationship between the debts of a firmand other forms of capital.
Money to pay for a firms assets can come from shareholders, profit retainedby a business, or money borrowed from lenders
When we look at gearing we ask the question;‘what % of the firms money has come from lenders’?
Why measure gearing?As we have already said gearing looks at the relationship between the debts
of a firm and other forms of capital. It is useful to know this relationship because;
• If gearing is low it tells us that the firm has the ability to borrow money to invest
• If gearing is high it tells us that firm might have difficulty in increasing borrowings
• If gearing is low then profit will not be used making interest payments• If gearing is high it could mean a large part of profits are used in paying
interest payments and less profit is available for investment or for payment of dividends
What figures do we need to measure gearing?2012
(m)2011
(M)
Fixed Assets 247 231
Current Assets
Stock 147 141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets 241 286
Current Liabilities 303 261
Net Current Liabilities/Assets
(62) 25
Total Assets less Current Liabilities
185 256
Long-term Liabilities 24 29
Shareholders’ Funds 161 227
Capital Employed 185 256
For gearing we use figures from the firms balance sheet.
The figures we use are• Long Term Liabilities
• Share holders Capital or Funds
On the account to the left we can seeboth Long Term liabilities
and Shareholders Funds
times 100 1 =
+
2012 (m)
2011(M)
Fixed Assets 247 231
Current Assets
Stock 147 141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets 241 286
Current Liabilities 303 261
Net Current Liabilities/Assets
(62) 25
Total Assets less Current Liabilities
185 256
Long-term Liabilities 29
Shareholders’ Funds 227
Capital Employed 185 256
Gearing =
Long Term Liabilities (LTL) 100 LTL + Shareholders Funds 1
= gearing %times
The formula we use tocalculate gearing is
242424161161
12.9%
Balance Sheets can be presentedin slightly different ways.
In this example from a past paper question, LTL are shown above the balancing figure of £1742m, and Shareholders Capital is broken down into ShareCapital and Reserves.
But we still use the same figuresand the same formula. So -
times 100 1 =
+
1773
1773 174250.4%
Of course we could have put in the figures for Share capital (£91m) and Reserves (£1651m) instead of Total Shareholders Capital – but the answer would be the same
Discussing your answer
So you have calculated gearing, what can you say about your answer?
The firm has a gearing level of just above 50%. This tells us that around half of the firms capital has been borrowed. 50% is not too high a figure, after all it makes sense
to borrow money to expand, and use profits earned from the expansionto pay back the loan. If we look at the gearing figure for the previous year,
the result is 40.1%, so there has been quite a jump in borrowing. This means increased interest payments, but if borrowing has resulted
profitable investments, this should not be a problem.
Example Question2012
(m)2011
(M)
Fixed Assets 247 231
Current Assets
Stock 147 141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets 241 286
Current Liabilities 274 261
Net Current Liabilities/Assets
(33) 25
Total Assets less Current Liabilities
214 256
Capital Employed
Long-term Liabilities
Shareholders’ Funds
Share Capital
Reserves
Capital Employed 214 256
Analyse the change in the firms gearing over the two years.
times 100 1 =
+
times 100 1 =
+
2011
2012
494949
140140
6767
19.1%
747474
1061063434
34.5%