Gearing

What does gearing mean?

where a business gets its capital from

What does gearing show to potential investors?

where a business finance has come from and what proportion of its finance come from long-term loans rather than share capital

What is the equation for gearing?

non current liabilities / total equity x 100

What does the borrowing of money a business wants depend on?

on its profitability and the value of its assets

What does a firm have to pay more of when they borrow more money?

more interest rates

How will paying more interest rates affect businesses?

it will affect their profits and the dividend paid to shareholders

When will a business be in high gear?

when their gearing ratio is over 50%

What does being in high gear mean?

the business is borrowing more money so they get to where they want more quickly

What are the benefits of high gearing?

extra funds for expansion
increase profits
gain a competitive advantage

When would a business likely choose to go into high gearing?

during a growth phase

What are the risks of high gearing?

might not be able to afford the repayments
might not make enough profit to pay back loan

What is an advantage of high gearing for investors of the business?

if profits are high then they can expect to see large dividends and a big increase in share price

When will a business be in low gear?

when their gearing ratio is under 25%

What does being in low gear mean?

the business has low levels of borrowing

What is an acceptable level of gearing for a business?

between 25% and 50%

What are the ways of reducing gearing?

focus on profit improvement
repay long term loans
retain profits rather than pay dividends
issue more shares
convert loans into equity

What are the ways of increasing gearing?

focus on growth
convert short term debt into long term loans
buy back ordinary shares
pay increased dividends out of retained earnings