Position ratios

In this lesson

1. 0:00 Position ratios: gearing overview
2. 0:39 Why gearing matters: risk implications
3. 0:57 Interest cover explained
4. 2:01 Worked example: calculating gearing
5. 3:50 Interpreting gearing changes

About this lesson

In this lesson, you'll work through the two gearing formulas, understand why higher gearing signals increased risk, and see how interest cover reveals whether operating profits can comfortably cover interest obligations. By the end, you'll be able to analyse a company's financial position and explain what these ratios mean for lenders, shareholders, and the business itself. Gearing measures the proportion of long-term debt within a company's capital structure and can be calculated as either debt divided by equity, or debt divided by debt plus equity (both expressed as a percentage). The key insight is that higher gearing means higher risk—more debt obligations mean greater pressure to cover interest payments from profit and cash. Interest cover, calculated as profit before interest and tax divided by finance costs, tells you how many times a company can cover its interest payments from operating profit. A ratio below 2 suggests real risk that the company may struggle to meet its obligations. The lesson walks you through a practical example using a company's statement of financial position, showing you how to extract the relevant figures, perform the calculations, and interpret what the results mean. You'll see how gearing increased from 14.3% to 21.7% when debt doubled, and learn to explain why this matters—both for the increased financial risk and for shareholders' prospects of receiving dividends. Understanding how to calculate and communicate these ratios confidently will strengthen your analysis in case study and exam scenarios.

Duration: 4m