Ratios

Leverage/Gearing Ratios

Under the syllabus, leverage/gearing ratio only consists of one ratio - debt to equity ratio.

Debt to Equity

Measure the amount of debt per dollar of equity.

 

 

Notes: Terminology

  • For a debt to equity ratio below 100% - describe the business as lowly geared

  • For a debt to equity ratio above 100% - describe the business as highly geared

 

Interpretations

Acceptable ratio levels are dependent on each industry; therefore, debt to equity ratios should be compared to industry averages as well as past performance.

 

Some businesses can still be efficient despite being highly geared. The debt to equity ratio needs to be considered with other ratios of the business and industry average before an operate comment can be made. 

 

Generally speaking, the usual interpretations are:

 

Lowly Geared (Below 100%)

Compare to industry – usually good as it means the business does not have significant debt obligations.

Highly Geared (Above 100%)

Compare to industry – usually provides some concern as the business has a large level of debt obligations

 

Handy Tip: Comment with Times Interest Earned

Comment on the debt to equity ratio with the Times Interest Earned ratio. The Debt to equity ratio shows the level of gearing, while the Times Interest Earned ratio is an indicator of how effective that gearing is.

 

For example, if a company had a debt to equity ratio of 300%, but had a times interest earned ratio of 15 (above industry average), then it can be concluded that the highly geared position does not pose a risk as the times interest earned ratio indicates the company is able to comfortably meet its debt arrangements.

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