methods of improving gearing

Cambridge International AS & A Level Business (9609) – Revision Notes

1. Business & Its Environment (AS)

2. Human Resource Management (HRM) Snapshot (AS)

• Workforce Planning & Recruitment – forecasting labour needs, job analysis, sourcing (internal promotion vs external recruitment), selection methods (structured interviews, psychometric tests, assessment centres).
• Motivation & Leadership – Maslow’s hierarchy of needs, Herzberg’s two‑factor theory, McGregor’s Theory X & Y, contemporary intrinsic vs extrinsic reward systems, transformational leadership.
• Training & Development – induction, on‑the‑job training, e‑learning, mentorship, career pathways; link to productivity, employee retention and succession planning.
• Performance Management – setting SMART objectives, appraisals (annual, 360°), linking performance to pay (bonus schemes, commission), dealing with under‑performance.
• Employment Relations – trade unions, collective bargaining, employee rights (e.g., TUPE), health & safety legislation, grievance and disciplinary procedures.

3. Marketing Snapshot (AS)

• Marketing Mix (4 Ps)
  • Product – core vs augmented product, product life‑cycle stages, branding.
  • Price – cost‑plus, penetration, skimming, psychological pricing, price elasticity.
  • Place – distribution channels, logistics, e‑commerce, channel conflict.
  • Promotion – advertising, sales promotion, public relations, personal selling, digital marketing.
• Market Research & Segmentation – primary vs secondary data, quantitative (surveys, questionnaires) vs qualitative (focus groups, interviews); segmentation criteria (demographic, psychographic, behavioural, geographic).
• Positioning & Branding – creating a unique value proposition; example: a UK coffee chain positions itself as “ethical, locally roasted” to appeal to environmentally‑aware consumers.

4. Operations Management Snapshot (AS)

• Transformational Process – inputs (raw materials, labour, capital) → processes (manufacturing, service delivery) → outputs (goods/services).
• Production Methods – job (customised), batch (small runs), flow (mass production), lean (waste reduction), mass customisation.
• Inventory Management – Economic Order Quantity (EOQ) model, safety stock, Just‑In‑Time (JIT) to minimise holding costs.
• Capacity Planning – measuring capacity (units per period), utilisation, bottleneck analysis; decisions on outsourcing vs in‑house production.
• Quality Control – Total Quality Management (TQM), ISO standards, Six Sigma, continuous improvement.

5. Finance & Accounting (AS)

5.1 Need for Finance & Sources

• Internal sources – retained earnings, sale of non‑core assets, working‑capital optimisation.
• External sources – equity (share issue, venture capital, angel investors), debt (bank loans, bonds, overdrafts, leasing), trade credit.

5.2 Cash‑Flow Forecasting

Projects cash inflows and outflows over a set period (usually monthly). A positive forecast shows the ability to meet short‑term obligations; a negative forecast signals the need for additional financing or cost reduction.

5.3 Cost Classifications & Break‑Even Analysis

Break‑Even Point (units) = Fixed Costs ÷ (Selling Price per unit – Variable Cost per unit).

5.4 Budgets & Variance Analysis

• Budget types – static (unchanged for the period), flexible (adjusted for actual activity), cash, master.
• Variance = Actual – Budgeted; favourable (cost saving) vs unfavourable (overspend) variances are analysed to control performance.

5.5 Gearing – Detailed Study

What is Gearing?

Gearing measures the proportion of a company’s capital that is financed by debt rather than shareholders’ equity. It indicates financial risk and the ability to meet interest and principal repayments.

Common Gearing Ratios

• Debt‑to‑Equity Ratio $$\text{Gearing} = \frac{\text{Total Debt}}{\text{Total Equity}} \times 100\%$$
• Debt‑to‑Capital Ratio $$\text{Gearing} = \frac{\text{Total Debt}}{\text{Total Debt} + \text{Total Equity}} \times 100\%$$

Numerical Example

Debt‑to‑Equity Ratio:

$$\text{Gearing} = \frac{150,000}{250,000} \times 100\% = 60\%$$

Interpretation: 60 % of the capital structure is financed by debt – a moderate level of financial risk.

Why Gearing Matters

• High gearing can amplify profits when sales are strong but magnifies losses during downturns.
• Lenders and investors use gearing to assess creditworthiness and the cost of capital.
• Regulators may impose maximum gearing limits in sectors such as utilities, banking or insurance.

Methods of Improving (Reducing) Gearing

1. Reduce Debt
   • Early repayment of long‑term loans or bonds.
   • Refinance high‑interest overdrafts into longer‑term, lower‑rate facilities.
   • Negotiate debt restructuring – extend maturities, obtain interest holidays or convert debt to equity.
2. Increase Equity
   • Issue new ordinary shares (rights issue, private placement, public offering).
   • Retain a larger proportion of profits rather than paying dividends.
   • Convert existing debt into equity via a debt‑to‑equity swap.
3. Improve the Asset Base
   • Re‑value property or other assets upward, which raises equity indirectly.
   • Sell non‑core assets and use the proceeds to repay debt.
4. Operational Measures
   • Boost profitability – higher retained earnings increase equity.
   • Implement cost‑saving initiatives to free cash for debt repayment.
   • Improve working‑capital management (e.g., faster collections, better inventory control) to generate cash for reducing debt.

Practical Step‑by‑Step Plan

1. Analyse the latest financial statements to establish the current gearing level.
2. Identify the most expensive debt (highest interest rate) for priority repayment.
3. Develop a capital‑raising plan – consider rights issue, venture capital or strategic investors.
4. Communicate the strategy clearly to shareholders and lenders to maintain confidence.
5. Monitor the gearing ratio each reporting period and adjust actions as required.

Potential Trade‑offs

• Issuing new shares may dilute existing shareholders’ voting power and earnings per share.
• Early debt repayment reduces cash reserves, potentially limiting growth, R&D or marketing investment.
• Higher equity can lower return on equity (ROE) if profit growth does not keep pace with the larger equity base.

Summary

Gearing is a key indicator of financial risk. By reducing debt, increasing equity, improving the asset base, or enhancing operational profitability, a business can lower its gearing ratio, become less risky, and improve its attractiveness to investors and lenders. Each method involves trade‑offs that must be weighed against the company’s strategic objectives.

6. External Influences – PESTLE Analysis (A Level)

7. Business Strategy Toolkit (A Level)

8. Integrated Revision Checklist

1. Define and differentiate the various enterprise types, and explain factors of production, opportunity cost and the dynamic environment.
2. Describe the roles of entrepreneurs and intrapreneurs, their typical qualities, barriers they face, and their contribution to national development.
3. Outline the key components of a business plan and evaluate its advantages and limitations.
4. Explain how business structure and size affect communication, control and economies of scale.
5. State and apply SMART objectives for different business aims.
6. Identify primary and secondary stakeholders and suggest appropriate management approaches.
7. Conduct a concise PESTLE analysis for a chosen company.
8. Recall the main HRM concepts** – recruitment, motivation, training, performance management and employee relations.
9. Explain the marketing mix and how market research informs product positioning.
10. Describe key operations choices – production methods, inventory control, capacity planning and quality management.
11. Calculate and interpret the break‑even point and common cost classifications.
12. Prepare a simple cash‑flow forecast** and discuss its significance.
13. Compute both Debt‑to‑Equity and Debt‑to‑Capital gearing ratios and explain what they reveal about financial risk.
14. List and evaluate at least three methods of improving gearing**, discussing potential trade‑offs.
15. Apply two strategic tools (e.g., SWOT and Porter’s Five Forces) to assess a company’s strategic position.