Acca financial Accounting (FA) Study Text ac ca (FA)

7 Financial 

position 

When assessing the financial position of a business the main focus is its 

stability and exposure to risk. This is typically assessed by considering the way 

the business is structured and financed. This is referred to as 

gearing

. 

In simple terms gearing is a measure of the level of external debt an entity has 

(e.g. outstanding loans) in comparison to equity finance (i.e. share capital and 

reserves). 

 

 

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Chapter 20 

KAPLAN PUBLISHING

 

393 

Measuring gearing 

There are two methods commonly used to express gearing as follows. 

Debt/equity ratio: 

Long term debt

Equity

 

Percentage of capital employed represented by borrowings: 

Long term debt

Equity + long term debt

 

Long term debt includes non-current loan and redeemable preference share 

liabilities. 

Equity includes share capital (and premium) balances plus reserves 

(revaluation reserve, retained earnings). 

Note:

 Redeemable preference shares are treated as liabilities because they 

must be repaid and are therefore debts of the entity. Irredeemable preference 

shares do not have to be repaid and are therefore treated the same as ordinary 

shares and included in equity.