ACCA MA Syllabus F. Performance Measurement - Measuring Risk - Notes ^{5 / 13}

Measurement of risk considers the financial risk incurred by borrowing.

Capital gearing is concerned with the amount of debt in a company’s long-term capital structure. It provides a long-term measure of liquidity. It can be calculated as:-
Long-Term Debt x 100%
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Long-term Debt + Equity
If the firm has excessive debt, then the need to pay interest before dividends will increase the risks faced by shareholders if profits fall.

Interest cover is expressed as:
Profit before interest and tax = Number of times
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Interest paid
This ratio represents the number of times that interest could be paid out of profit before interest and tax.

Long term liabilities $20,000
Shareholders funds and reserves $30,000
Operating profit (PBIT) $5,000
Finance cost $1,000

What is the capital gearing ratio?

20,000/(20,000+30,000) * 100% = 40%

What is the interest cover ratio?

5,000/1,000 = 5 times