ACCA Financial Management (F9) Certification Practice Exam

What does Financial Gearing measure?

1. Debt relative to total equity

2. Operational efficiency of assets

3. Fixed Assets + Current liabilities

4. Market value of assets over liabilities

The correct answer is: Debt relative to total equity

Financial gearing measures the relationship between a company's debt and its equity, specifically highlighting how much debt is used to finance the company's operations compared to its equity. This ratio is crucial for assessing a company's financial leverage and understanding the risk profile associated with its capital structure. A higher level of financial gearing indicates that a company is relying more heavily on borrowed funds, which can increase potential returns but also raises financial risk during economic downturns when earnings may decline. By focusing on debt relative to total equity, financial gearing helps investors and creditors evaluate the risk of a company's financial obligations versus its owners' investment. This insight is particularly important when considering the company's ability to meet its debt obligations and maintain a sustainable business model over the long term. In contrast, the other options provide different measurements or concerns that are not aligned with the concept of financial gearing. Operational efficiency of assets pertains to how effectively a company uses its resources to generate revenue, rather than the capital structure itself. The formula involving fixed assets and current liabilities does not pertain to measuring gearing but instead looks at other aspects of the balance sheet. Lastly, the market value of assets over liabilities focuses on valuation and the overall health of the balance sheet rather than the specific leverage position signified by financial gearing.