ACCA Financial Management (F9) Certification Practice Exam

Which term measures the degree to which an organization's activities are funded by borrowed funds?

1. Financial gearing

2. Operational gearing

3. Liability ratio

4. Debt equity ratio

The correct answer is: Financial gearing

The term that measures the degree to which an organization's activities are funded by borrowed funds is known as financial gearing. This concept refers to the proportion of debt in relation to equity within a company’s capital structure. A higher level of financial gearing indicates greater reliance on borrowed funds, which can amplify both returns and risks for equity shareholders. Essentially, it helps analysts understand the extent to which a business is utilizing debt to finance its operations compared to its equity, which in turn affects its risk and return profile. In contrast, operational gearing pertains to the relationship between fixed and variable costs in a company's operations, influencing the degree to which changes in sales affect profits. The liability ratio generally refers instead to the total liabilities of a company relative to its total assets or equity, but it does not specifically relate to the concept of funding an organization's activities. The debt equity ratio, while closely related to financial gearing, is often viewed as a separate measure that specifically compares total debt to total equity rather than focusing on the broader funded activities. Thus, financial gearing is the most appropriate and direct measure of the reliance on borrowed funds.