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Hello
I was wondering what should be done in a question like this:
Long term liability = 10m
Share Capital = 5m
Retained earnings = 5m
Find the Financial gearing ratioShould I use D/E or D/D+E ?
Also in some questions, E is taken as the value of share capital alone while others have taken it as the sum of all Equity accounts values.
The options are not helping either. Really confused about this.The gearing ratio should be compute as: Long-term liability / (Share capital + retained earnings). You should consider all equity FSLIs while computing the gearing ratio.
popularks: Please do not answer in this forum, because this is the Ask the Tutor Forum and you are not the tutor. But please do help people in the other FM forum.
danny969:
There are actually two separate issues here.
Firstly there are two standard measures of gearing: one is D/E and the other is D/(E+D). Obviously they produce different results. In the exam use D/(E+D) unless the examiner specifies differently (most times he makes it clear how he wants it measured).
Secondly, E is the value of equity. If we are calculating the gearing based on book values (i.e. SOFP values) then E is share capital + reserves (including retained earnings). However if we are calculating it on market values (which is much more sensible if we have the information in the question) then E is just the market value (i.e. the value on the stock exchange).
I do explain the reason for this and why it is better to use market values, in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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