{"id":100,"date":"2025-10-26T08:00:38","date_gmt":"2025-10-26T08:00:38","guid":{"rendered":"http:\/\/ecourse.co.uk\/8135\/?p=100"},"modified":"2025-10-29T13:06:09","modified_gmt":"2025-10-29T13:06:09","slug":"week-7-uw-18","status":"publish","type":"post","link":"https:\/\/ecourse.uk\/8135\/?p=100","title":{"rendered":"Week 6 [10]: Financial structure &#8211; Capital and Income Gearing"},"content":{"rendered":"<p><span style=\"line-height: 24px;\"><img loading=\"lazy\" decoding=\"async\" class=\"alignnone wp-image-1474\" src=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2022\/10\/GEARING-GRAPH.jpg\" alt=\"\" width=\"506\" height=\"383\" srcset=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2022\/10\/GEARING-GRAPH.jpg 1216w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2022\/10\/GEARING-GRAPH-300x227.jpg 300w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2022\/10\/GEARING-GRAPH-1024x776.jpg 1024w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2022\/10\/GEARING-GRAPH-768x582.jpg 768w\" sizes=\"auto, (max-width: 506px) 100vw, 506px\" \/><\/span><\/p>\n<p>This week we will look at the <strong>financial structure<\/strong> of a company. We&#8217;ll look at how companies are financed, and the relationship between debt and equity, as well as the nature of long and short term finance. We&#8217;ll use the financial statements of the <strong>Hunting plc<\/strong> to support the session. You can download the group&#8217;s financial statements (for 2024) from <strong><a href=\"https:\/\/media.huntingplc.com\/investors\/results-and-reports\/2024\/Hunting-annual-report-and-results-2024.pdf\" target=\"_blank\" rel=\"noopener noreferrer\">here<\/a> or from <a href=\"https:\/\/www.gov.uk\/government\/organisations\/companies-house\">Companies House<\/a>.<\/strong><\/p>\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_84 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/ecourse.uk\/8135\/?p=100\/#Lecture_material\" >Lecture material<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/ecourse.uk\/8135\/?p=100\/#Gearing\" >Gearing<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/ecourse.uk\/8135\/?p=100\/#Exam_type_questions\" >Exam type questions<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/ecourse.uk\/8135\/?p=100\/#Additional_resources_on_liquidity_and_cash_flow_management\" >Additional resources on liquidity and cash flow management<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/ecourse.uk\/8135\/?p=100\/#Additional_Supportive_Reading\" >Additional Supportive Reading<\/a><\/li><\/ul><\/nav><\/div>\n<h4><span class=\"ez-toc-section\" id=\"Lecture_material\"><\/span><strong>Lecture material<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><span style=\"line-height: 24px;\">The lecture material for today&#8217;s session is available <\/span><strong style=\"line-height: 24px;\"><a href=\"http:\/\/www.ecourse.co.uk\/gearing\/capitalstructure2025.pdf\" target=\"_blank\" rel=\"noopener noreferrer\">here<\/a><\/strong><span style=\"line-height: 24px;\">.<\/span><\/p>\n<hr \/>\n<p>Here is the graph of Hunting plc&#8217;s share price over the past five years.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-1988\" src=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2025\/10\/Hunting_2025.jpg\" alt=\"\" width=\"684\" height=\"424\" srcset=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2025\/10\/Hunting_2025.jpg 684w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2025\/10\/Hunting_2025-300x186.jpg 300w\" sizes=\"auto, (max-width: 684px) 100vw, 684px\" \/><em>Source: Google Finance, 23 October 2025<\/em><\/p>\n<p>What does this tell you about the performance and\/or prospects of Hunting plc?<\/p>\n<hr \/>\n<h4><span class=\"ez-toc-section\" id=\"Gearing\"><\/span>Gearing<span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p>The relationship between debt and equity is called <strong>gearing<\/strong> (leverage in the US). The higher the proportion of borrowing to shareholders capital the higher the financial risk of <em><strong>both<\/strong> <\/em>equity shareholders and lenders. Risk here means the variability of the returns to shareholders and lenders.<\/p>\n<p>This is demonstrated in the following spreadsheet.<\/p>\n<p>The first line shows example figures from the financial statements. Capital employed is analysed into debt and equity. The relationship between equity and debt is gearing &#8211; here 20%.<\/p>\n<p>Continuing along the first line, there are example figures from the Income Statement. Interest is 10% of debt (10% 0f 200). Tax is calculated at an effective rate of 18% of profit after interest. Profit after interest and tax as a percentage of equity (148\/800) (19%) is calculated &#8211; this is return equity.<\/p>\n<p><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-1249\" src=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2020\/12\/GEARING-EXCEL-MODEL-2021-02-01_19-12-50.jpg\" alt=\"\" width=\"1131\" height=\"500\" srcset=\"https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2020\/12\/GEARING-EXCEL-MODEL-2021-02-01_19-12-50.jpg 1131w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2020\/12\/GEARING-EXCEL-MODEL-2021-02-01_19-12-50-300x133.jpg 300w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2020\/12\/GEARING-EXCEL-MODEL-2021-02-01_19-12-50-1024x453.jpg 1024w, https:\/\/ecourse.uk\/8135\/wp-content\/uploads\/2020\/12\/GEARING-EXCEL-MODEL-2021-02-01_19-12-50-768x340.jpg 768w\" sizes=\"auto, (max-width: 1131px) 100vw, 1131px\" \/><\/p>\n<p>The &#8216;LOW GEARING&#8217; section deals with a company which has the same capital employed as the &#8216;basic data&#8217; company i.e. 1000. However, its gearing is low &#8211; 5%. The table shows that a profit of 400 will give equity shareholders a return of 34%. If profit fell to 50 the return on equity would fall to 4% &#8211; a drop of 30 percentage points.<\/p>\n<p>The &#8216;HIGH GEARING&#8217; section shows a company with high gearing (70%). When gearing is high a profit of 400 will give equity shareholders a return of 90%. If profit fell to 50 return on equity would fall to -5% &#8211; a drop of 85 percentage points.<\/p>\n<p>So the variability of returns (and hence financial risk) to the <em>shareholders<\/em> is higher when gearing is high. So high gearing increases the financial risk of both lenders and shareholders.<\/p>\n<p>However, in the right circumstances gearing can be used creatively to increase the returns to equity shareholders (here, 34% to 90%).<\/p>\n<hr \/>\n<h4><span class=\"ez-toc-section\" id=\"Exam_type_questions\"><\/span><strong>Exam type questions<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><strong>Your exam will contain TWO short essay questions. Here are typical examples:<br \/>\n<\/strong><\/p>\n<p><strong>Question 1<\/strong><\/p>\n<p>\u2018It is evident, however, that operational and financial gearing have the common feature that an increase in either &#8230; reduces the earnings available to shareholders and thereby increases their risk.\u2019<\/p>\n<p>John Ogilvie, Financial Strategy<br \/>\nCIMA, 2009, p160<\/p>\n<p><strong>Required<\/strong><\/p>\n<p><strong>Demonstrate how increasing financial gearing increases the risk of both lenders and shareholders.<br \/>\n<\/strong><\/p>\n<p><strong>Discuss whether or not more efficient working capital management can reduce financial gearing.<\/strong><\/p>\n<p><strong>Question 2<\/strong><\/p>\n<p>a) \u00a0Using the financial statements of Flybe Group plc for 2016 (you can download from <strong><a href=\"https:\/\/s3.eu-west-2.amazonaws.com\/document-api-images-live.ch.gov.uk\/docs\/Bl0nEFwNTn7tNfGoNV7NdBu4JpDPiSIYQeI9x2BO1zU\/application-pdf?X-Amz-Algorithm=AWS4-HMAC-SHA256&amp;X-Amz-Credential=ASIAWRGBDBV3JF6PUSMK%2F20251023%2Feu-west-2%2Fs3%2Faws4_request&amp;X-Amz-Date=20251023T101741Z&amp;X-Amz-Expires=60&amp;X-Amz-Security-Token=IQoJb3JpZ2luX2VjEIr%2F%2F%2F%2F%2F%2F%2F%2F%2F%2FwEaCWV1LXdlc3QtMiJGMEQCIBb3ymIQXsCykfKXxNLdOTO8wSl3xIU1KY272LZouqfEAiBUwmyWYMGHifICxaCBrjhCtGqTV2YyUJv7hGzSLhlIwCqBBAhDEAUaDDQ0OTIyOTAzMjgyMiIM1G2dIbfpPTRgZCEPKt4Dd4OTbAWARxC762KNeimoP2nkaWMTOkEh4j5vN%2FcYkwebg6vlMhllCuA7TpOFUxLnToL3cci%2FJdp2oKkhCo1XtOD79oHskyup6vXrraFUjwpJ8YHXLEGZZ5vtqb3y7QTaENoXzmmgXHoHmE9Jqx4rxA7jPXCIQX03Ftz3JJrrbU58UCcNXJk1gdV7PeQqEIUUazjj5j5XiSGqGpXPJICCG8spEo%2Fv%2FAztFilj9NHH%2FIc%2BrNgXbvLY9W5GMlxFS%2FVAyefZeSy1sa2s6l3Zfw%2F50Jzst%2B7AIuqlLLSd8RT%2FODWCgKAjlc80yOJFkOLC2xIbuV7FxSfDLxrnbUAc8C4gObs1cea0%2BQKqQKQi2AHiHah9E2xh%2BPPG4PPsFhk6LdFKm%2BGdesdS95Pfq49%2BJo8WvGWl284qOwtYDGmtu7ANKCIFwMIyj0LnaDRC4%2F0w%2BwPJ%2Bkily669ti%2Br4OhKfau%2F1NoeguhhShZdX3cc70HMpdU%2FBU1orlzCqFdufudRGXOIRe1ncIQBkmiKubUgi2b02kIHq3gve%2FZTJ7TE%2B11i6Qr5Bgg2QPYvFTVCICnG%2BD4tNmwE8QFhL2Sh%2BWFXU0yeqwHzwoOujbih6lTdYxwJNCkfjo17WH64ACKukQm1%2BzCj%2BufHBjqmAU8RhHa1Ml76dwVhshKq0EHjE4LX%2FMjppRJDnrpkUNSStgUA%2Bhk%2FxJizsVJsF2OqCCLge3h1eV%2FF1PZRUdeEQDCfG%2BghWtwpK6P9Cs2h7o3mrFATmkYrkc05YJANJlWcwXJ2dSOtSuYhOB6qRvpZieO0E7nQwGWJGjKJnXRIMbKl9otQnQmniG11fiEWN8AwmOw%2FcZYrN6fQnrr%2BGCQzcdBfwaiZXk0%3D&amp;X-Amz-SignedHeaders=host&amp;response-content-disposition=inline%3Bfilename%3D%22companies_house_document.pdf%22&amp;X-Amz-Signature=d2d3b27fab1af3ff71ef8c425b92ccecc7a8a3d40d6d51fc8fc02b86175ae753\" target=\"_blank\" rel=\"noopener noreferrer\">here<\/a>)<\/strong> calculate capital and operating gearing ratios for 2016 and 2015 and assess the level of gearing of the group over the two years.<\/p>\n<p>b) \u00a0Compare your calculations with Flybe&#8217;s own calculation of gearing (page 109) exploring the reasons for any differences. Which measurement basis do you think is the best?<\/p>\n<p>c) \u00a0An <strong><a href=\"http:\/\/shares.telegraph.co.uk\/fundamentals\/?epic=FLYB\" target=\"_blank\" rel=\"noopener noreferrer\">investment section<\/a><\/strong> in a newspaper gives the following gearing information for Flybe:<\/p>\n<p style=\"padding-left: 30px;\">Net Gearing (%)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 44.12<br \/>\nGross Gearing (%)\u00a0 \u00a0 \u00a0 \u00a072.89<br \/>\nDebt Ratio (to 1)\u00a0 \u00a0 \u00a0 \u00a0 \u00a049.26<br \/>\nDebt-to-Equity Ratio \u00a0 \u00a00.36<\/p>\n<p>Research how these ratios have been defined. How to these values compare with your own calculations and the company&#8217;s calculation?<\/p>\n<hr \/>\n<h4><span class=\"ez-toc-section\" id=\"Additional_resources_on_liquidity_and_cash_flow_management\"><\/span><strong>Additional resources on liquidity and cash flow management<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p>We&#8217;ll also try and find the time to look at a short case study &#8211; <strong><a href=\"http:\/\/ecourse.co.uk\/qlemonstane.pdf\" target=\"_blank\" rel=\"noopener noreferrer\">Lemonstane plc<\/a><\/strong> &#8211; \u00a0on the use of the statement of cash flows to evaluate liquidity. There is suggested solution <strong><a href=\"http:\/\/www.ecourse.co.uk\/slemonstane.pdf\" target=\"_blank\" rel=\"noopener noreferrer\">here<\/a><\/strong>.<\/p>\n<hr \/>\n<h4><span class=\"ez-toc-section\" id=\"Additional_Supportive_Reading\"><\/span><strong>Additional Supportive Reading<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><a href=\"https:\/\/www.accaglobal.com\/uk\/en\/student\/exam-support-resources\/fundamentals-exams-study-resources\/f9\/technical-articles\/optimum-capital-structure.html\" target=\"_blank\" rel=\"noopener\"><strong>Optimum capital structure<\/strong><\/a> ACCA F9 Revision Material<\/p>\n<p><a href=\"https:\/\/academic.oup.com\/book\/3631\/chapter-abstract\/144955272?redirectedFrom=fulltext#no-access-message\" target=\"_blank\" rel=\"noopener\"><strong>Capital Structure Decisions of a Public Company<\/strong><\/a> Oxford Academic (you may be able to get free access)<\/p>\n","protected":false},"excerpt":{"rendered":"<p>This week we will look at the financial structure of a company. We&#8217;ll look at how companies are financed, and the relationship between debt and equity, as well as the nature of long and short term finance. We&#8217;ll use the financial statements of the Hunting plc to support the session. You can download the group&#8217;s [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":"","_links_to":"","_links_to_target":""},"categories":[3],"tags":[],"class_list":["post-100","post","type-post","status-publish","format-standard","hentry","category-lectures"],"_links":{"self":[{"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/posts\/100","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=100"}],"version-history":[{"count":40,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/posts\/100\/revisions"}],"predecessor-version":[{"id":2000,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=\/wp\/v2\/posts\/100\/revisions\/2000"}],"wp:attachment":[{"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=100"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=100"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/ecourse.uk\/8135\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=100"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}