Calculations

• Gearing Ratio:

  • Measures how much of a firm's 'capital employed' is made up of 'non-current' liabilities.
  • Where non-current liabilities is long term debt e.b bank loans, mortgages
• Return on Capital Employed (ROCE) = Operating profit / Total capital employed x 100%
• Calculating Gearing:

  Total Debt/ Total Equity + Total Debt x 100

  
• High Gearing

  Greater than 50%

  High debt
• Low Gearing

  Less than 20%

  Little Debt
• Gearing 25% - 50%

  Business is not overburdened by debt
• Why a high Gearing Ratio may be concerning:

  1. higher costs because business will have to pay off more debt
  2. At risk of interest rates increasing
  3. economic market conditions may worsen and business may be unable to pay off debts
  4. reduced financial flexibility - opportunity cost of debt
  5. Investors see signs of instability
• ROCE is useful for:

  • evaluating overall performance of business
  • provide a target return for projects