1. MODULE 4 RATIO ANALYSIS A2 Marketing and Accounting and Finance Gearing

2. Measures extent to which a business is dependent on borrowed funds, ie its financial stability. Measures proportion of capital employed provided by borrowed funds. Definition, Calculation and Interpretation Definition and Calculation

3. Concerns long-term liabilities - excludes short-term loans or overdrafts, or money owed to suppliers / creditors. Definition, Calculation and Interpretation Definition and Calculation

4. 1 Long-term loans x 100 = X% 2 Capital Employed Gearing: 1 Bank loans + Debentures. 2 Loan capital + Share capital + Reserves. Definition, Calculation and Interpretation Definition and Calculation

5. Example: Loans £300,000. Share capital £1m. Reserves £200,000. Gearing = 25% (300,000 / £1,200,000 X 100). Loans £300,000. Share capital £1m. Reserves £200,000. Gearing = 25% (300,000 / £1,200,000 X 100). Definition, Calculation and Interpretation Definition and Calculation

6. If more than 50%, firm said to be highly geared. NB Other ways of calculating gearing: If more than 50%, firm said to be highly geared. NB Other ways of calculating gearing: Definition, Calculation and Interpretation Interpretation Total liabilities x 100 Equity plus total liabilities Long-term debt x 100 Equity When making comparisons - ensure same formula used.

7. The higher the gearing, the higher the risk, because: The Risks and Rewards Involved regular interest payments - effect on cash and net profit. loans secured on fixed assets - lender right to claim asset on which loan is secured. debtors priority over owners/shareholders if business fails. regular interest payments - effect on cash and net profit. loans secured on fixed assets - lender right to claim asset on which loan is secured. debtors priority over owners/shareholders if business fails.

8. The Risks and Rewards Involved Rate of return on assets / projects financed by borrowing should exceed the cost. Risk to owner/shareholder lower - potential reward greater - no need to provide further capital. Debt is cheaper than equity as tax deductible. Rate of return on assets / projects financed by borrowing should exceed the cost. Risk to owner/shareholder lower - potential reward greater - no need to provide further capital. Debt is cheaper than equity as tax deductible.

9. Circumstances where High Gearing may be Attractive trading conditions look good. interest rates are low. internal funds are too limited. trading conditions look good. interest rates are low. internal funds are too limited. May seem attractive when:

10. Circumstances where High Gearing may be Attractive specialise in ‘necessities’ rather than ‘luxuries’. are well-established, strongly branded. specialise in ‘necessities’ rather than ‘luxuries’. are well-established, strongly branded. Businesses able to take on much higher gearing, when:

11. How Gearing can be Reduced Reduce debt or Increase equity or Both.

12. How Gearing can be Reduced Issuing new ordinary shares (increases share capital) Retaining profits within business (increases reserves) Revaluation of fixed assets (increases reserves). Issuing new ordinary shares (increases share capital) Retaining profits within business (increases reserves) Revaluation of fixed assets (increases reserves). Equity could be increased by:

13. How Gearing can be Reduced Selling off under-utilised fixed assets or selling new shares - using money from sale to pay off existing debt. Debt / could be increased by:

14. Choosing Different Sources of Finance Factors to be taken into account: Purpose. Objectives. Legal Structure. Financial Position. Age. Factors to be taken into account: Purpose. Objectives. Legal Structure. Financial Position. Age.

15. Choosing Different Sources of Finance Size. Reputation. Government Policy. Interest Rates. Size. Reputation. Government Policy. Interest Rates.

16. - END - RATIO ANALYSIS A2 Marketing and Accounting and Finance Gearing