Gearing CRMC

katiekitkat123

I know there are lots of helpful information on the gearing equations on the forum and I have looked through them but I'm still a bit stuck and My part 2 CRMC exam is tomorrow.

My problem is this there are two ways to calculate gearing when doing credit management

Long term loans / net assets + long terms loans x 100

or

Debt (trade payables+long term loans) / Debt (trade payables+long term loans) + Equity (share holders funds) x 100

The thing is I dont know which one to use when :crying:

I have to practice question one is

due within one year
Trade payables £1500
Net current assets £750

due after one year
Long term loans £1500
Net assets £4750

Equity
Share capital £250
Retained earnings £4500
Shareholders funds £4750

The answer is 38.71%
Debt (trade payables+long term loans) / Debt (trade payables+long term loans) + Equity (share holders funds) x 100

The second practice question is

due within one year
Trade payables £2100
Net current assets -£150

due after one year
Long term loans £1000
Net assets £1050

Equity
Share capital £200
Retained earnings £850
Shareholders funds £1050

The answer is 48.78%
Long term loans / net assets + long terms loans x 100

I am so confused why with the same type of figs you use debt for the top question to work out gearing and loans in the second question, can anyone explain why as I dont want to use the wrong one in my exam as the number it will come out with is wildly different :001_unsure:

Chelle

We were told to use long term loans/long term loans + equity x 100 for CRMC.

We sat it back in December and everyone used that method.

The other way which includes all debt is for FNPF ratios.

SandyHood

The key is:

Read the question

If you read the following:

Gearing (total debt/(total debt plus equity))
Note total debt includes short and long term

Then you have no doubt what to do:
......total debt ....... x 100 ........................Means exactly that: add together all the short term and long term
total debt plus equity ..............................borrowing and find what this debt represents as a % of the total ..............................................-..............amount invested (I.e this total debt plus the value of equity)

....Bank overdraft + Long term loans
Bank overdraft + Long term loans + Net assets

The examiner does not expect you to be a mind reader, if he wants you to look at total debt he will ask you.
Don't look at the ratios as generic things to be learned so you can pass an exam, try to understand why we go through this whole ratio calculation process. It is not an end in itself.
Today, in May 2012 if you are approached by a customer wanting to have credit terms you really need to be confident that the money that customer agrees to pay for purchases from you will really be paid for. Firms that don't are going out of business up and down the country.

So don't go to a text book and say "ok gearing in the book says ... this or that.."
Look at the customer's accounts and say - this firm owes £xxxx, some of it is long-term debt, some of it is short-term debt. And now they want us to let them have 60/70/80 days between buying something and paying for it.

If you think about the risk of default, you'll have a better chance of understanding gearing.
After all, what might you do if you heard a supplier used:
......long term debt ....... x 100
long term debt plus equity

You might say, let's make sure we get this credit!!... so take out some short term debt (e.g. increase the overdraft) and pay off part of the long term debt! And then as if by magic the credit rating will shoot up ( and the firm will still be just as much of a risk and in just as much debt as was when it had a lot more long term loans and a much smaller overdraft)

SandyHood

Looking at the two questions your post refers to:

The second practice question is

due within one year
Trade payables £2100
Net current assets -£150

due after one year
Long term loans £1000
Net assets £1050

Equity
Share capital £200
Retained earnings £850
Shareholders funds £1050

Comes from Alpha Limited and refers to the Accounts for X Limited

Gearing is defined as: (total debt/(total debt plus equity))

There are no short term borrowings, but there are £1,000 of long-term loans
Shareholders funds are £1,050
So the gearing is:
.............. £1,000 x 100 = 48.78%
...... £1,000 + £1,050

SandyHood

Looking at the other questions your post refers to:

practice question one is

due within one year
Trade payables £1500
Net current assets £750

due after one year
Long term loans £1500
Net assets £4750

Equity
Share capital £250
Retained earnings £4500
Shareholders funds £4750

I have not managed to find the complete balance sheet for this one.
But on the basis of the previous posting I would use the same formula.
I do not consider that trade payables in the normal course of events is a gearing debt (others do) but I would be consistent with my earlier posting

Comes from "I don't know"

I expect that Gearing is defined as: (total debt/(total debt plus equity))

You would need to check whether there are any short term borrowings, we know there are £1,500 of long-term loans
And Shareholders funds are £4,750
So based on what we know the gearing is:
.............. £1,500...... x 100 = 24.00%
...... £1,500 + £4,750

If you can either point me to the question, or identify if there is no cash in the current assets I will try to help further, but until the additional information comes to light, I disagree with the answer you have given 38.71%

katiekitkat123

SandyHood wrote: »

Looking at the other questions your post refers to:


I have not managed to find the complete balance sheet for this one.
But on the basis of the previous posting I would use the same formula.
I do not consider that trade payables in the normal course of events is a gearing debt (others do) but I would be consistent with my earlier posting

Comes from "I don't know"

I expect that Gearing is defined as: (total debt/(total debt plus equity))

You would need to check whether there are any short term borrowings, we know there are £1,500 of long-term loans
And Shareholders funds are £4,750
So based on what we know the gearing is:
.............. £1,500...... x 100 = 24.00%
...... £1,500 + £4,750

If you can either point me to the question, or identify if there is no cash in the current assets I will try to help further, but until the additional information comes to light, I disagree with the answer you have given 38.71%

This question comes from a chapter 2 activity given by my lecturer, there is no where in the question that gives how they would like gearing calculated, the full b/s is as below

Accounts for De Grass ltd (extracts)

Income statement
£'000
Sales Revenue £10,000
Cost of Sales £7,000
Gross Profit £3,000
Distribution cost £800
Admin costs £550
Profit from ops £1650
Interest payment £210
Profit on ordinary activities before taxation £1440
Tax £475
Profit for year £965

SOFP

Non current assets
Tangible assets £5500

Current assets
Inventories £1100
Trade receivables £950
Cash £200

Due within one year
Trade payables £1500
Net current assets £750

Due after one year
Long term loans £1500
Net assets £4750

Equity
Share capital £250
Retained earnings £4500
Shareholders funds £4750

I have the answer sheet from this and it gives the answer for gearing as 38.71% and De Gass being a very low risk when grating credit OP% 16.5% interest cover 7.86 Current ratio 1.5:1

Any light you could shed on this would be great,

My lectures have not taught this unit to us, we have just be told use the ratios from budgeting and gone over the part 1 answers over and over, we've had no practice or input for the written part, no real explanation of why the ratios are uses and why we use what figures

katiekitkat123

I have just found in the credit scoring part that gearing is debt/debt+equity