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# 会计代写|金融会计代考Financial Accounting代写|ACCT1101 Gearing and its implications

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## 会计代写|金融会计代考Financial Accounting代写|Gearing and its implications

The relationship between equity and long-term borrowings is known as the gearing (or leverage) of the financial structure. There are two common ways of calculating a gearing ratio:
(a) compare the debt (i.e. long-term borrowings) with the equity; or
(b) compare the debt with the capital employed (i.e. equity plus debt).
Formulae for the two gearing ratios are:
(a) Gearing $=\frac{\text { Debt }}{\text { Share capital }+\text { Reserves }}=\frac{\text { Debt }}{\text { Equity }}$

(b) Gearing $=\frac{\text { Debt }}{\text { Share capital }+\text { Reserves }+\text { Debt }}=\frac{\text { Debt }}{\text { Equity }+\text { Debt }}$
For Bread Co. the figures are:
(a) 20X1: $0.0$ per cent
$20 \times 2: \frac{20}{106}=18.6$ per cent
(b) 20X1: $0.0$ per cent
$$20 \times 2: \frac{20}{126}=15.9 \text { per cent }$$
For this company, the shareholders might want to maximise the proportion of the total capital employed that is financed by debt rather than by themselves, as now explained. As shown in Table 7.3, with non-current debt of 20 (measured in $€ 000$ ), the ROCE for Bread Co. for $20 \mathrm{X} 2$ was $19.0$ per cent and the ROE was $20.8$ per cent.

If we were to increase the gearing ratio so that, for example, the same capital employed of 126 consisted instead of capital plus reserves of 66 and debentures (with 10 per cent interest) increased to 60 , then the ratios for $20 \mathrm{X} 2$ would give the same ROCE but a much improved return to the equity investors, as follows:
$$\operatorname{ROE}=\left(\frac{24-6}{126-60}\right)=\frac{18}{66}=27.3 \text { per cent }$$
There are limits to the feasibility of increasing the proportion of debt, however. First, it is riskier to lend to a business that already has significant debt and therefore increased interest rates would be needed to attract such lending – if, indeed, it could be attracted at all. Second, consider what happens to a highly geared structure when operating profits fall. Suppose that Bread Co. alters its capital structure (as above) to give owners’ equity of 66 and debentures of 60 , but then in $20 \times 3$ the level of operating profit falls back to that of $20 \mathrm{X} 1$, i.e. 12 . This would lead to $20 \mathrm{X} 3$ ratios as follows:
ROE for $20 \mathrm{X} 3=\left(\frac{12-6}{66}\right)=9.1$ per cent
ROE for $20 \mathrm{X} 3=\left(\frac{12}{126}\right)=9.5$ per cent

Now the gearing is working in the other direction, to magnify the fall in returns suffered by the shareholders rather than to magnify the rise. The end result is that ROE is less than ROCE. It is, of course, perfectly possible for ROCE to be positive and ROE to be negative. It should be remembered also that a company which cannot afford to pay dividends does not have to pay them. However, a company that cannot afford to pay interest still legally has to pay it. This can be the road to bankruptcy.

## 会计代写|金融会计代考Financial Accounting代写|Further analysis of ROE and ROCE

In practice, business is much more complicated than for Bread Co. The text and case studies in this book are not designed to cover all possible complications that might be met, but to enable the diligent reader to work out how to deal with them. To begin this process, two complications are mentioned at this stage.
What is long-term borrowing?
If a particular liability is defined as one of those ‘falling due within one year’ or some similar phrase, the reality behind this may not be clear-cut. For example, consider the amounts set out in Table $7.4$ as falling due within one year.

Does it look as though all of these items are genuine short-term liabilities arising from the trading and operating cycle or do some of them seem to be a continuing source of finance that happens to be legally constructed so as to be renewable within one year? It seems likely that the bank loans and overdrafts, and possibly also the commercial bills payable, are being used to finance the activities of the business, rather than being an integral part of those operating activities.

If that view is taken, then these items might be included as long-term borrowings for the purposes of calculating capital employed. Further, the interest on those ‘current’ liabilities must then also be added back to net profit (or not deducted from operating profit) in arriving at the correct return figure for the ROCE ratio. This may involve a very careful analysis and division of the interest payable amount between the various loans to which it relates. However, care is needed here. We are only discussing the treatment for gearing calculations. If risk of liquidity problems were being discussed (see Section 7.5), some of these financing items might definitely be ‘current’.

## 会计代奇金融会计代考FINANCIAL ACCOUNTING代 Э|GEARING AND ITS IMPLICATIONS

$a$ 比较债务i.e.long-termborrowings用股权；或者
$b$ 比较债务与使用的资本i.e. equityplusdebt.

$a$ 传动装置 $=\frac{\text { Debt }}{\text { Share capital + Reserves }}=\frac{\text { Debt }}{\text { Equity }}$
$b$ 传动装置 $=\frac{\text { Debt }}{\text { Share capital + Reserves + Debt }}=\frac{\text { Debt }}{\text { Equity + Debt }}$
$a 20 \times 1: 0.0$ 百分
$20 \times 2: \frac{20}{106}=18.6$ 百分
b20x1: $0.0$ 百分
$$20 \times 2: \frac{20}{126}=15.9 \text { per cent }$$

\text { ROE }=\left(\frac{24-6}{126-60}\right)=\frac{18}{66}=27.3 \text { per cent }


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