3.5.2 Ratio analysis Flashcards
1
Q
Gearing ratio
A
measures the proportion of a business capital provided by debt
2
Q
a business is highly geared if
A
it has used debt to fund all of its capital investment
3
Q
Why use gearing?
A
- measure of the financial health of a business
- focusses on the level of debt in the financial structure of the business
- high gearing can mean high business risk
4
Q
Formula for gearing
A
non - current liabilities / total equity + non-current liabilities x 100
5
Q
High gearing is
A
gearing ratio is higher than 50%
6
Q
Low gearing is
A
gearing ratio is lower than 20%
7
Q
Benefit of high gearing ratio
A
- less capital required to be invested by the shareholders - bank not owners so have less input on business
- debt can be relatively cheap source of finance compared to dividends
- east to pay interest if profits and cash flows are strong
8
Q
Benefits of low gearing
A
- less risk of defaulting on debts
- less exposed to interest rate changes
- shareholders rather than debt providers have influence over the business
- business has the capacity to add debt if required
9
Q
ROCE
A
return on capital employed
- will vary between industries
- based on a snapshot of balance sheet
- comparisons over time and with key comparisons are most useful
10
Q
Capital employed
A
non-current liabilities + total equity
11
Q
Why is ROCE useful?
A
- evaluate the profitability of investments
- provide a target return for future individual projects - helps with investment appraisals
- benchmarking performance with competitors or make comparisons over time
12
Q
Formula for ROCE
A
Operating profit / total equity + non-current liabilities x 100
13
Q
What steps can a business take to improve its ROCE?
A
- Selling obsolete machinery so there is less cost for the same productivity
- Paying off debt to reduce liabilities
