Why is the Gearing Ratio useful?
The Gearing Ratio is useful as it provides information about one aspect of an organisation’s risk; it’s financial risk. A highly geared business could face the following potential problems: • In times of low profits the ordinary shareholders may receive no dividends, due to the high level of fixed interest payments which put a strain on profits. • The company may find it hard to raise further finance, and banks and other financial institutions may be reluctant to lend the business further funds. • In the case of a public limited company (plc), share prices may fall as ordinary shareholders begin to sell their shares. • If profits are poor, the business may not be able to pay the interest due on its fixed interest capital. Therefore any assets used as security would be at risk. In certain situations it may be acceptable for a business to be highly geared: • If the borrowed funds can be used in the business to make a higher return than that paid to the lenders of the funds. • If there wa
