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Dear Tutor
When should we use the formula
Gearing Ratio = Non Current Liabilities/ (Non Current Liabilities + Market Value Of Share)
and
Gearing Ratio = non Current Liabilities/ ( Non Current Liabilities + Book Value of Share Capital + Reserves)?What difference can the formulas make while determining the solvency of a company?
Isn’t using the market value of Shares more accurate than considering the book value?Yes – using the market value of shares is a much better measure.
Only use the book values if either the question specifies it (for example, if a condition imposed by lenders is that the gearing based on book values does not exceed a certain limit), or if there is no information about market values (unlikely, but then you would obviously have no choice 🙂 ).
Thankyou Sir
I’ve something really silly to ask as well.
When do we use Gearing %= Non current Liabilities / Equity?Both are valid ways of measuring gearing even though obviously they give different answers.
In the exam questions the examiner almost always defines which of the two measure he wants. If he doesn’t then use equity / (equity + long-term debt)
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