ZIMSEC O Level Business Studies Notes: Business Finance and Accounting: Ratio Analysis:Gearing ratios

  • Gearing refers to the extent to which a business’s assets are financed using debt capital versus equity capital
  • Remember the balance sheet equation:
  • Assets = Capital (Equity) + Liabilities (Debt)
  • What this means is that all assets are purchased using either equity or debt finance
  • Equity refers to all the money that belongs (is attributable) to the owners of the business
  • It includes capital and retained earnings/ploughed back profit
  • Debt finance refers to money attributable to outside parties such as loan from bank, debentures, trade creditors, bank overdraft etc
  • So in other words the balance sheet/accounting equation simply expresses the fact that a portion of the business’s assets were bought using money belonging to the owners of the business while another portion was bought using borrowed money
  • Gearing is a measure of how much of the assets were bought using equity and how much of the assets were bought using debt finance
  • Gearing ratios are also known as debt-equity ratios
  • There are various ratios but the most popular is:
  • \mathrm{Gearing \quad Ratio = \dfrac{Debt\quad Capital}{Debt\quad Capital+ Equity} x 100}
  • Remember debt capital is the same as long term liabilities
  • The result is expressed in percentage terms
  • For example a business has a capital of $5 000, retained earnings of $ 2 000 and a long term loan of $1 000
  • The gearing would be:
  • \mathrm{ \dfrac{1000}{1000+ (5000+2000)} x 100}
  • 12.5% 
  • This means a 12.5% of assets are attributable to debt finance
  • If the gearing ratio is high the business is said to be highly geared
  • If the ratio is low the business is said to be lowly geared
  • A highly geared business has a higher risk of defaulting on its interest and loan payments
  • A lowly geared business is missing on some of the opportunities of debt finance

To access more topics go to the O Level Business Notes

- See latest Zimbabwe grocery prices -

Deals

SEE LATEST SUPERMARKET PRICES, SHOP FOR GROCERIES VIA WHATSAPP
SEE PRICES & NEWS
We publish the latest grocery prices from Zimbabwean supermarkets. We also deliver groceries online

Quick NetOne, Telecel, Africom, And Econet Airtime Recharge

If anything goes wrong, click here to enter your query.