Gearing ratio By Lachy, Vicente and Aprile

Gearing ratio

• Gearing measures the percentage of a firms capital employed that comes from long-liabilities, such as debentures and mortgages.

• The gearing ratio is an accounting used to assess a firms long term liquidity position.

• Shareholders and investors are interested in the gearing ratio as it helps assess the level of risk.

Example

For example a firm long term liabilities total 5 million whilst its capital employed is 20 million, calculate the gearing ratio?

Step 1: Locate the formula in the data booklet. Step 2: Identify numbers given from extract and substitute into formula Step 3: State as a percentage Gearing ratio = 25%

What does this all mean?

• If the gearing ratio is over 50%, the firm is considered to be ‘highly geared’. Such firms a vulnerable for increases in interest rate since it has to make large repayments of interest and capital.

• If the gearing ratio is less than 50%, then the firm is considered to be ‘low geared’. Since its repayments do not form a significant proportion of its regular outgoings.

Relation to financial statements

Balance statement

• In regard to the balance sheet capital employed will be represented at the bottom of the statement.

• In order to balance the statement the ‘money’ sourced from capital employed will be spread amongst fixed assets, current and non-current assets.