Business – 10.4 Finance and accounting strategy – Accounting data and ratios | e-Consult
10.4 Finance and accounting strategy – Accounting data and ratios (1 questions)
Login to see all questions.
Click on a question to view the answer
Model Answer:
When dividends are reduced, the company retains more profit. If the retained earnings are applied to reduce borrowings, the equity base rises (through retained earnings) and the debt level falls, both of which lower the gearing ratio.
| Metric | Before policy change | After policy change |
| Total debt (£) | £200,000 | £150,000 |
| Equity (£) (including retained earnings) | £300,000 | £340,000 |
| Gearing ratio (Debt ÷ Equity) | 200,000 ÷ 300,000 = 0.67 | 150,000 ÷ 340,000 ≈ 0.44 |
Investor perception:
- Lower gearing is generally viewed positively because it indicates reduced financial risk and a stronger balance sheet.
- Retaining earnings signals that management is focusing on long‑term growth, which can attract investors seeking stability.
- However, some income‑focused investors may be disappointed by the lower dividend, potentially leading to a short‑term share price dip.