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

Interpretation of financial statements 

394

 

KAPLAN PUBLISHING

 

 

Therefore highly geared entities (high level of debt to equity) are 

considered to be riskier but comparatively cheaper to service than lower 

geared entities (and vice versa). 

Low-geared business entities also tend to provide scope to increase 

borrowings when potentially profitable projects are available as they are 

generally perceived to be less risky by banks and can therefore borrow 

more easily. 

Interest cover 

This is normally expressed as: 

Interest cover

 =

 

PBIT

Interest payable

 

Interest cover indicates the ability of an entity to pay interest out of profits 

generated: 

•

 

low interest cover indicates to shareholders that their dividends are at risk 

(because most profits are eaten up by interest payments) and 

•

 

the entity may have difficulty financing its debts if its profits fall 

•

 

interest cover of less than two is usually considered unsatisfactory.