Gearing

• What does gearing focus on in a business?

  The capital structure of the business
• How is the gearing ratio related to liquidity?

  It focuses on long-term financial stability
• What does gearing measure in a business?

  The proportion of assets financed by borrowing
• What is the implication of high gearing for a business?

  Higher risks due to mandatory debt payments
• When can gearing be financially sound for a business?

  With strong, predictable cash flows
• What is the formula for the gearing ratio?

  Gearing (%) = Long-term liabilities / Capital employed x 100
• If long-term liabilities are £1,200k and capital employed is £5,655k, what is the gearing ratio?

  21.2%
• What constitutes long-term liabilities?

  Loans due after one year, preference shares, mortgages
• How is capital employed calculated?

  Share capital + retained earnings + long-term liabilities
• How can the gearing ratio be evaluated?

  • Gearing > 50%: Highly geared
  • Gearing < 25%: Low gearing
  • Gearing 25%-50%: Normal for established businesses
• Why is long-term debt not necessarily bad for a business?

  It is usually cheaper and reduces shareholder investment
• What factors determine a sensible level of gearing for a business?

  The ability to grow profits and generate cash flow
• How does a mature business handle gearing compared to an unpredictable one?

  Mature businesses can handle higher gearing levels
• What can shareholders and management do regarding the level of gearing?

  • Change or manage the level of gearing
  • Implement strategies to adjust capital structure