Gearing, ROCE and Analysing Ratios

Gearing is financial terminology that refers to the amount of a firm’s operations that are financed by borrowing compared to the firm’s own equity.
It is a ratio that indicates the relative proportion of shareholders’ equity and debt used to finance a company’s assets.
A high gearing ratio indicates high borrowing and can be risky as the company is heavily relying on debt. However, it also signifies high potential returns.
A low gearing ratio suggests financial stability since the company relies less on borrowed funds. This, however, may also indicate low potential returns.
ROCE stands for Return on Capital Employed. It is a financial ratio that measures a company’s profitability and the efficiency with which its capital is being used.
ROCE is calculated by dividing the firm’s Earnings Before Interest and Tax (EBIT) by its Capital Employed (i.e., Total Assets - Current Liabilities).
A higher ROCE percentage indicates greater efficiency in deploying resources, signalling a potentially more profitable company.
Serial analysis of multiple years’ ratios can help identify trends and patterns in a company’s financial performance.
Comparing a company’s ratios with those of its competitors can provide a measure of the firm’s performance in the industry context.
It’s important to keep in mind that various factors can affect ratios, including changes in market conditions, company strategy, and financial policies.
Analysing ratios gives potential investors, stakeholders, and managers a qualitative measure of a firm’s performance. For instance, the liquidity ratio can indicate how a company can pay off its short-term debts.
Remember not to blindly trust ratios. Always use ratios along with other financial and non-financial info to make more informed decisions.
Each ratio has a different level of importance depending on the company and the industry, so no single ratio is universally applicable.
Remember that finance is only one aspect of the firm’s overall performance and should not obscure other important areas like employee satisfaction, customer loyalty, and the quality of products and services.