9609 · 10.2.4
Gearing ratio flashcards
Revision flashcards for Cambridge 9609 Gearing ratio (syllabus 10.2.4). Flip, recall, then mark a real past-paper question.
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Gearing formula (Cambridge)?
Non-current liabilities ÷ Capital employed × 100% (or NCL ÷ (Equity + NCL)).
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High gearing meaning?
Large proportion of finance from long-term debt — higher interest obligations and bankruptcy risk if profits fall.
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Low gearing meaning?
Mostly equity-financed — lower risk but shareholders may want more leverage for growth.
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When is high gearing attractive?
Stable profits, low interest rates, ROCE > cost of debt — magnifies returns to shareholders.
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Interest cover?
Operating profit ÷ Finance costs — how many times interest can be paid.
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Gearing and 5.2 finance?
Choice of debt vs equity affects gearing; links to sources of finance topic.
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Risk in recession?
High gearing firms suffer when revenue falls but interest still due.
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Compare with ROCE?
ROCE must exceed cost of debt for borrowing to boost shareholder returns.
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What is the formula for the gearing ratio?
Gearing Ratio = (Non-current liabilities / Capital employed) × 100. Capital employed is calculated as Total Equity + Non-current liabilities.
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What does a gearing ratio of 65% indicate about a business?
It indicates high gearing, as over half (65%) of its long-term capital is financed by debt. This means the business has a high level of financial risk and is vulnerable to changes in interest rates.
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Identify two components of 'non-current liabilities' on a Statement of Financial Position.
1. Long-term bank loans. 2. Debentures. These are both forms of debt that are not scheduled for repayment within the next 12 months.
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Why is a highly geared company considered financially risky by lenders?
Because it already has significant debt obligations and high fixed interest payments. This reduces its capacity to service new debt, making it a higher-risk borrower and potentially increasing the cost of any new loans.
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What is the strategic benefit of having a low gearing ratio?
A low gearing ratio provides greater financial flexibility. The business can more easily secure new debt finance for strategic opportunities like expansion, acquisitions, or investment, without becoming over-leveraged.