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IAI Actuarial Core Principles · Business Finance · Structure and methods of financing a company

A company's capital structure consists of ordinary shares, retained earnings and long-term bank loans. Which of the following is the most common way of measuring its financial gearing?

Financial gearing is measured by comparing borrowings with equity, either as debt to equity or debt to total capital employed. The other ratios describe liquidity, margin, dividend payout or receivables collection, not how the company is funded.

  1. ARatio of debt (borrowings) to equity, or debt to total capital employedCorrect
  2. BRatio of current assets to current liabilities
  3. CRatio of operating profit to sales
  4. DRatio of dividends paid to profit after tax
  5. Ratio of trade receivables to annual credit sales

Explanation

Financial gearing measures the proportion of a firm's funding that comes from fixed-return debt, typically as debt/equity or debt/(debt+equity). The other ratios measure liquidity, profitability, payout and credit control, not capital structure.

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