ACCA FM Syllabus E. Business Finance - The impact of sources of finance on financial position - Notes ^{3 / 6}

The things to look here for are primarily the levels of debt in comparison to equity

The higher levels of debt (relative to equity) means higher levels of financial gearing - this affects the volatility of EPS and also can increase cost of capital and so financial risk

Earnings are needed to pay interest (check the interest cover ratio), but also cash is needed to pay off the loans as they become due

Companies with high gearing then should not ideally look for more debt and therefore would be wiser to lease rather than borrow to buy.

Operational gearing looks at the amount of fixed overheads you have compared to variable. the higher the fixed costs the higher the operational gearing

High operational gearing makes a company very open to falls in revenue causing a huge drop in profits - and conversely a rise in revenue can increase profits hugely