Financial Accounting · Analysis of financial statements

Gearing and Investor Ratios for ACCA Financial Accounting

Updated 11 October 2026 · Fact-checked

Gearing shows how much of a company's capital is debt, so it measures financial risk. Interest cover shows if profit can pay interest. Investor ratios (EPS, P/E, dividend cover, dividend yield) show returns to shareholders. Pick the formula, take figures from the statements, calculate, then comment on what the result means.

Understand Gearing and Investor Ratios

Gearing is about how a company is financed. A company can use equity (share capital and reserves) or debt (loans, loan notes and often preference shares). Debt carries interest that must be paid whatever profit is. So more debt means more financial risk.

A highly geared company has a large share of debt in its capital. When profits are good, shareholders gain because debt is a cheap source of funds. When profits fall, interest still has to be paid and profit left for shareholders can drop sharply. Lenders also worry about security. High or low is relative: compare with prior years, similar companies and the industry.

Interest cover tests the risk from a different angle. It asks how many times profit before interest and tax can pay the interest charge. A low figure means little safety if profit falls.

Investor ratios help shareholders judge returns. Earnings per share (EPS) is profit for ordinary shareholders divided by the number of ordinary shares. P/E ratio compares the share price with EPS, showing how many years of earnings the market is paying. A high P/E suggests the market expects growth or sees low risk. Dividend cover shows how many times the dividend is covered by earnings, so how safe it is and how much is retained. Dividend yield shows the cash return as a percentage of the share price.

Dividend cover and dividend yield are often confused. Cover looks at the company's side: can it afford the dividend? Yield looks at the investor's side: what return do I get on the price I pay?

Key formulas to remember

Gearing (debt ÷ equity): Gearing = Long-term debt ÷ Equity × 100%; Equity is share capital plus reserves. Debt includes long-term loans and usually preference shares. Use the definition the question gives.
Gearing (debt ÷ capital employed): Gearing = Long-term debt ÷ (Debt + Equity) × 100%; Capital employed here is debt plus equity. This gives a lower percentage than debt ÷ equity for the same company. Do not mix the two when comparing.
Interest cover: Interest cover = Profit before interest and tax ÷ Finance costs; Answer is in times. Use operating profit (profit before finance costs and tax).
Earnings per share: EPS = (Profit after tax − preference dividends) ÷ Number of ordinary shares in issue; Answer is in cents or $ per share. Simple version assumes no change in shares during the year.
Price earnings ratio: P/E = Market price per share ÷ EPS; Answer is in times (years).
Dividend cover: Dividend cover = Earnings (EPS) ÷ Ordinary dividend per share; Equivalent to profit for ordinary shareholders ÷ ordinary dividends. Answer is in times.
Dividend yield: Dividend yield = Dividend per share ÷ Market price per share × 100%; Use the ordinary dividend per share and the current share price.

How to solve Gearing and Investor Ratios questions

Use this routine for any ratio question on gearing or investor returns.

1Read the requirement and note which ratios are asked for and any definition the question gives.
2Write each formula down before you use numbers.
3Pick out the figures. Check whether they are profit before or after tax, and which items count as debt or equity.
4Calculate and round as instructed. Keep the unit: percentage, times or $ per share.
5Compare with the prior year or other benchmark given.
6Say what the change means: more or less risk, better or worse return, safer or riskier dividend.
7If asked for a view, give one reason for the movement and a limit, such as different accounting policies or a single year's data.

Quickest way: Formula, figures, meaning

When to use it: Use this in Section A objective questions where you must calculate one ratio in about two or three minutes.

Identify the ratio from the wording: risk from debt means gearing; ability to pay interest means interest cover; return per share means EPS or yield.
Underline the exact numbers you need in the question and ignore the rest.
Do the arithmetic once, then sanity check: cover should be positive, gearing below 100% for debt ÷ capital employed.
For multiple choice, look at your answer against the options. If two options look close, recheck whether you should have used debt ÷ equity or debt ÷ capital employed.
For number entry, follow the rounding rule and enter only the number.

Common mistakes in Gearing and Investor Ratios

Using profit after interest in interest cover.
Students take the profit figure at the bottom of the statement or the one just above tax.
Fix: Use profit before finance costs and tax. Add the interest back if you start from profit before tax.
Mixing the two gearing formulas.
Both are common and give different percentages.
Fix: Use the definition in the question. If none is given, state the formula you use and apply it to every year.
Leaving preference dividends in EPS.
Students use total profit after tax without checking for preference shares.
Fix: Deduct preference dividends first, because EPS belongs to ordinary shareholders only.
Confusing dividend cover with dividend yield.
Both use dividends and sound alike.
Fix: Cover = earnings ÷ dividend (times, about safety). Yield = dividend ÷ share price (%, about return).
Saying high gearing is always bad.
Students learn gearing as risk and stop there.
Fix: Say it raises financial risk, but can boost returns to shareholders when profits are strong. Link to interest cover.
Using nominal value instead of market price in P/E or yield.
Share capital figures appear in the statement of financial position, so they are easy to grab.
Fix: P/E and yield need the market price. Nominal value is only for counting shares or working out dividends.

Worked examples

Example 1

A company has long-term loans of $200,000, share capital of $300,000 and reserves of $100,000. Profit before interest and tax is $90,000 and finance costs are $20,000. Calculate (a) gearing as debt ÷ equity, (b) gearing as debt ÷ (debt + equity), and (c) interest cover.

Show the solution

Equity = $300,000 + $100,000 = $400,000.
(a) Debt ÷ equity = 200,000 ÷ 400,000 = 50%.
(b) Debt + equity = 200,000 + 400,000 = $600,000. Gearing = 200,000 ÷ 600,000 = 33.3%.
(c) Interest cover = 90,000 ÷ 20,000 = 4.5 times.

Answer: (a) 50%; (b) 33.3%; (c) 4.5 times. Profit covers interest 4.5 times, so interest looks affordable at present.

Example 2

A company has 1,000,000 ordinary shares in issue. Profit after tax is $450,000. Preference dividends are $50,000. Ordinary dividends are $200,000. The market price is $6.00 per share. Calculate EPS, P/E, dividend cover and dividend yield.

Show the solution

Earnings for ordinary shareholders = 450,000 − 50,000 = $400,000.
EPS = 400,000 ÷ 1,000,000 = $0.40 per share (40 cents).
P/E = 6.00 ÷ 0.40 = 15 times.
Dividend per share = 200,000 ÷ 1,000,000 = $0.20.
Dividend cover = 0.40 ÷ 0.20 = 2 times.
Dividend yield = 0.20 ÷ 6.00 × 100 = 3.33%.

Answer: EPS $0.40; P/E 15 times; dividend cover 2 times; dividend yield 3.3%. Half of earnings are paid out and half retained.

Exam tips

Read for definitions in the question. Gearing is the ratio most often defined differently, so follow the wording given.
In number entry questions, check the unit and rounding instruction before you type.
For multiple response questions, work out each ratio separately, then test every statement against your answers.
In Section B, always add a short comment after the calculation. Marks are often given for the interpretation.
Remember that high P/E and high yield are not the same: a high yield on a falling share price may signal trouble.

Practice questions from Analysis of financial statements

Gearing and Investor Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Gearing and Investor Ratios: frequently asked questions

Is a high gearing ratio good or bad?

A high gearing ratio means more risk, because interest must be paid whatever profit is. It can still increase shareholder returns when profits are strong. Judge it with interest cover and by comparison with past years and similar companies.

What is the difference between dividend cover and dividend yield?

Dividend cover is earnings divided by the dividend and shows how safe the dividend is, in times. Dividend yield is dividend per share divided by market price and shows the cash return to an investor, as a percentage.

How do I calculate interest cover?

Divide profit before interest and tax by finance costs. The result is in times. A higher figure means profit can pay interest more easily.

What does the price earnings ratio tell me?

It shows how many years of current earnings the market price represents. A higher P/E usually means the market expects growth or sees lower risk. Compare it with similar companies, not in isolation.