ACCA Financial Management (F9) Certification Practice Exam

What does the term 'Financial Gearing' relate to in financial analysis?

1. Long-term profitability

2. Short-term liquidity

3. Debt financing compared to equity financing

4. Operating efficiency

The correct answer is: Debt financing compared to equity financing

The term 'Financial Gearing' refers specifically to the relationship between debt financing and equity financing within a company's capital structure. It measures the extent to which a company uses borrowed funds (debt) to finance its operations and growth, relative to the funds contributed by shareholders (equity). High financial gearing indicates that a company relies more on debt to finance its activities, which can increase both potential returns and risks, particularly regarding the company’s ability to meet its financial obligations during downturns. Conversely, low financial gearing suggests a higher reliance on equity financing, which may be perceived as less risky since it indicates that the company may have more financial security and lower debt burdens. The other options do not directly relate to the concept of financial gearing. Long-term profitability focuses on a company's ability to generate profits over time, while short-term liquidity evaluates its capacity to meet short-term obligations. Operating efficiency concerns how effectively a company utilizes its resources to generate revenue, rather than the specific balance between debt and equity in financing its overall operations. Therefore, recognizing the significance of financial gearing is essential for assessing a company's financial leverage and risk profile.