ACCA Financial Management (F9) Certification Practice Exam

Gearing ratio indicates the level of:

1. Operating income

2. Financial risk

3. Liquidity

4. Asset efficiency

The correct answer is: Financial risk

The gearing ratio is a financial metric that measures the proportion of a company's borrowed funds (debt) to its equity. This ratio is essential for assessing the financial risk associated with a company's capital structure. A high gearing ratio indicates that a greater proportion of the company's financing is coming from debt rather than equity, which can lead to increased financial risk. This is due to the obligation to service debt through interest payments, which can become burdensome, especially if the company faces downturns in revenue. By understanding the gearing ratio, stakeholders can evaluate how leveraged a company is and the potential impact of interest rate fluctuations on its operations. A higher level of gearing generally indicates higher financial risk, as the company is more susceptible to economic downturns. In contrast, a lower gearing ratio suggests that the company relies more on equity financing, which typically carries less risk. Therefore, the gearing ratio provides valuable insights into the level of financial risk that a company carries, making it a crucial aspect of financial analysis in decision-making.