1. Calculating Gearing

2. What does gearing measure?
The gearing ratio looks at the relationship between the debts of a firm
and other forms of capital.
Money to pay for a firms assets can come from shareholders, profit retained
by a business, or money borrowed from lenders
When we look at gearing we ask the question;
‘what % of the firms money has come from lenders’?

3. Why measure gearing?
As we have already said gearing looks at the relationship between the debts of a firm and other forms of capital. It is useful to know this relationship because;
If gearing is low it tells us that the firm has the ability to borrow money to invest
If gearing is high it tells us that firm might have difficulty in increasing borrowings
If gearing is low then profit will not be used making interest payments
If gearing is high it could mean a large part of profits are used in paying interest payments and less profit is available for investment or for payment of dividends

4. What figures do we need to measure gearing?
2012
(m)
2011
(M)
Fixed Assets
247
231
Current Assets
Stock
147
141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets
241
286
Current Liabilities
303
261
Net Current Liabilities/Assets
(62) 25
Total Assets less Current Liabilities
185
256
Long-term Liabilities 29
Shareholders’ Funds
161
227
Capital Employed
For gearing we use figures
from the firms balance sheet.
The figures we use are
Long Term Liabilities
Share holders Capital or Funds
On the account to the left we can see
both Long Term liabilities
and Shareholders Funds

5. The formula we use to calculate gearing is
2012
(m)
2011
(M)
Fixed Assets
247
231
Current Assets
Stock
147
141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets
241
286
Current Liabilities
303
261
Net Current Liabilities/Assets
(62) 25
Total Assets less Current Liabilities
185
256
Long-term Liabilities 29
Shareholders’ Funds
227
Capital Employed
Gearing =
Long Term Liabilities (LTL) LTL + Shareholders Funds
= gearing %
times
times
100 1 = +
12.9% 24 24 24
161
161

6. Balance Sheets can be presented in slightly different ways.
In this example from a past paper question, LTL are shown above the balancing figure of £1742m, and Shareholders Capital is broken down into Share
Capital and Reserves.
But we still use the same figures
and the same formula. So -
times
100 1 = +
1773
50.4%
1773
1742
Of course we could have put in the figures for Share capital (£91m) and Reserves (£1651m) instead of Total Shareholders Capital – but the answer would be the same

7. Discussing your answer
So you have calculated gearing, what can you say about your answer?
The firm has a gearing level of just above 50%. This tells us that around half of the firms
capital has been borrowed. 50% is not too high a figure, after all it makes sense
to borrow money to expand, and use profits earned from the expansion
to pay back the loan. If we look at the gearing figure for the previous year,
the result is 40.1%, so there has been quite a jump in borrowing.
This means increased interest payments, but if borrowing has resulted
profitable investments, this should not be a problem.

8. Analyse the change in the firms gearing over
2012
(m)
2011
(M)
Fixed Assets
247
231
Current Assets
Stock
147
141
Debtors 70 59
Cash and Bank 24 86
Total Current Assets
241
286
Current Liabilities
274
261
Net Current Liabilities/Assets
(33) 25
Total Assets less Current Liabilities
214
256
Capital Employed
Long-term Liabilities
Shareholders’ Funds
Share Capital
Reserves
Example Question
Analyse the change in the firms gearing over
the two years.
2011
times
100 1 = +
19.1%
2012
times
100 1 = +
34.5% 74 74 74 49 49 49
140
140
106
106 34 34 67 67