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Click to edit Master title style,Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,*,*,Gearing ratio,23rd February 2015,Fateha Shaheen,Importance of gearing,Profits,reduced by interest payments,Balance Sheet,weakened if loans are greater than shareholder funds,Risk,borrowing increase the risk of a business,Note,we have not defined risk yet,see later,Borrowings have grown rapidly in the last 15 years,linked with financial crisis,but may be falling now.,How to calculate GR,There are three different ways it can be calculated.,In addition there are three different ways of presenting a balance sheet.,The data you need can be found in three different places.,The different methods of calc reflect a deep disagreement in finance on the distinction between equity&debt.,There be dragons here,Importance in summary,Impacts profits,Impacts risk,Impacts strength of balance sheet,Gearing ratio 1,Borrowings Long term,Divided by,Shareholders capital,(B/C)*100=gearing percentage,A low figure is good.,Low borrowing=low financial risk,Plenty of scope for more loans if needed,Gearing ratio 2,Long term borrowings,Add,Short term borrowings,Divided by,Shareholders capital or shareholders funds,(B1+B2)/C)*100,Gearing ratio 3,Borrowings,Divided by,Shareholders funds,Add,Borrowings,(B/(B+C)*100,Identifying the figures,Shareholders funds includes,Share capital,Share premium,Retained reserves or cumulative profits and loss account reserves,Other reserves such as merger reserve.,If losses are made SHF can be negative or zero,Tesco plc Equity millions,Share capital,402,Share premium account,4,896,Other reserves,40,Retained earnings,11,197,Equity attributable to owners of the parent,16,535,Non-controlling interests,88,Total equity,16,623,TESCO PLC BORROWINGS,Non-current liabilities,Financial liabilities:,Borrowings,9,689,Derivative financial instruments&others,600,Post-employment benefit obligations,(1,356),Deferred tax liabilities,(1,094),Provisions,(113),TESCO PLC GEARING RATIO,(9,689/16,263)*100=60%,Tesco plc long term&short term,Current liab,Millions 1,386,9,689+1,386=11,075,(11,075/16,263)=68%,THE PROBLEM OF BALANCE SHEET PRESENTATION,Theres more than one way of presenting a bal sheet,Could be Assets=Liabilities(all liabilities inc.capital),Could be Assets-ST liabilities=LT Liabilities+Capital,Note capital=shareholders funds,Assets-ST Liability-LT Liability=Capital,The final one is the easiest one to get gearing ratio,When collecting data you need a consistent balance sheet presentation,Three types of gearing ratio,If there are three versions,which is correct?,That depends,Some people look at borrowing in the same way they look at capital.,Others view borrowings as distinct from capital.,In my view borrowings are distinct from equity,Version 3 fits in with the first view,Version 1&2 fit in with my view,Economists and accountants,Economists view is that borrowings are similar to capital(equity,shareholders funds),Accountants view,the traditional view if you like,borrowings are distinct from capital&should never be confused.,See later economists theories of finance,the revolution in corporate finance,Economists and accountants,Also have different theories of risk.,Different theories of profits.,Different ideas on valuing assets.,More on this later.,I take the accountants view,but you may not agree with this.,You must why you dont agree with me.,Negative gearing ratio,Borrowings cannot be a negative figure.,Borrowings are a liability.,When they are paid off they fall to zero.,SHF can be a negative figure,if losses have wiped out the original capital.,Indicates a company in great difficulty,High gearing ratios,Some companies take on high levels of borrowing,leads to a high GR,But,there is another way to get a high GR,If a company makes losses,SHF fall.,As SHF become smaller the GR becomes bigger.,High GR can be caused by losses rather than borrowings.,The normal range of GR,GR can take a wide range of values,0%means no borrowings,100%means borrowings equal to SHF(in version 1 and 2),200%means borrowings twice as big as SHF(in versions 1 and 2),-20%means the company has made losses greater than SHF.,Results from green business research,A sample of green business companies showed a max GR=190%,Min GR=0%,Average GR=37%,Standard deviation of GR=46,These results were generated in 2012,Note the high standard deviation.,Some research questions,Are green business firms deleveraging as a result of financial crisis?,Are large companies deleveraging?,Is the share of profits taken up by interest pays falling.,Does a high GR lead to a high probability of bankruptcy?,
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