Question
Activity 2: Evaluation & Recommenda tion Required (a) Evaluate the financial gearing of the company based on the two ratios provided Your ovaluation must cover what each ratio represents , an analysis of the observed changes in oach ratio, the reasons behind such changes over the two years and the potential implications of such changes (b) If the company is considering raising finance to fund a new invostment manager (with reason) whether they opportunity, recommenc to the should consider raising the needed funds through borrowing
Answer
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Hugo
Elite · Tutor for 8 years
Answer
1. The Gearing ratio is trending upwards showcasing a bolstered reliance on borrowing, suggesting a riskier financial landscape.2. Additionally, a diminishing Interest cover ratio implies lesser earnings to cover interest costs of debts, leading to heightened financial distress risk and decreased autonomy.3. If the current trend prevails, further borrowings should be avoided unless crucial and unless there is a clear path to increased profitability. Improving the operating profit margin must be a focus.
Explanation
## Step1 :### **Evaluation of the Financial Gearing**The two key ratios presented, Gearing ratio and Interest cover, are used to analyze financial gearing or leverage, and represent debt-load and amount of operating profit.## Step2 :Gearing ratio rose from
in 2021 to
in 2022. A rise in the gearing ratio indicates higher reliance on outside sources such as loans, which may affect the company's level of risk. Meanwhile, Interest cover ratio, indicates the company's ability to make obligatory interest payments on its debt, which has decreased to 4 times from 12 times previously. A falling Interest cover ratio indicates a decrease in profit margin or an increase in debt burden.## Step3 :The changes of the above mentioned ratios might be affected by an increase in the company’s borrowings and/or decrease in its operating profit margin (profits to gross sales), both of which portend higher financial distress risk, decreased autonomy in decision making, and more financial strain in terms of debt repayment and rising costs.## Step4 :For recommending whether or not the manager should continue considering borrowing, we must take into account these trends. Since increasing loans also brings along financial risk, the organization should sport caution. Efforts to boost operating profitability alongside curtailing leveraged position via efficient means of funding should be the goal.