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Dear John,
Could you please explain me the question 200 YGV Co (Answer on page 143) of BPP Revision Kit.
I don’t understand why the solution gives two different scenarios regarding the calculation of gearing (with and without overdraft). So which gearing is more correct (with or without overdraft included)?
For the analysis of interest coveragre. The solution given is
“The current interest coverage ration is almost half of the sector average of 8. Although with the prior year, profit before tax it was 22 times. Following the bond issue, this would drop to 2.6 times which is a low level of cover compared to the sector average and may create operational issues for YGV”What is operation issues that YGV may face implied from the answer?
Thank you John very much
Gearing is calculated using the total long term borrowings. As to whether or not we include overdraft borrowings depends on whether the company intend to keep the overdraft for the long term or not. In this question it is not made clear whether they intend to keep the overdraft long term or not, which is why the examiner allowed either answer.
(Overdrafts always appear on the Statement of financial position as current liabilities, simply because the bank could in law always insist on it being repaid immediately – this has nothing to do with whether or not the company intend it to remain long term or not).With regard to the interest cover, because it is so low it means that the profits (before interest) would only have to fall by a small amount before they would be unable to pay the interest and therefore be in difficulties. It therefore will become much more important for them to control costs etc to make sure the profit doesn’t fall, which is an operational issue.
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