ACCA Financial Management (F9) Certification Practice Exam

Which ratio is known as the Gearing Ratio?

1. Book value of debt / Book value of equity

2. Total debts / Total assets

3. Shareholders' funds / Total assets

4. Debt / (Debt + Equity)

The correct answer is: Book value of debt / Book value of equity

The gearing ratio is a financial metric that indicates the relative proportion of a company's debt to its equity or its total capital. It serves as a measure of financial leverage and indicates how a company is financed through debt compared to its shareholders' equity. The correct answer reflects a calculation that compares the book value of debt to the book value of equity, illustrating how much of the company’s capital structure is funded by debt. A higher ratio suggests that a larger portion of the company's financing is coming from debt, which can indicate increased financial risk since the company is relying more on borrowed funds compared to equity investment. The other choices describe ratios that measure different aspects of a company's financial health. While total debts divided by total assets provides a view of the overall debt burden related to all assets, it does not specifically focus on equity. Similarly, the ratio of shareholders' funds to total assets highlights the portion of assets financed by equity, and the ratio of debt to (debt plus equity) is another way to express gearing, but typically the initial definition concerning the book value of debt versus equity is the most straightforward and direct representation of the gearing concept in traditional financial analysis.