How low gearing is driving profits

John Longstaff, director at BHP Corporate Finance.
John Longstaff, director at BHP Corporate Finance.
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The past 12 months have proved to be very testing for many businesses as the economy struggles slowly out of recession. Operating with a robust funding structure is vitally important for companies during these difficult times.

Following on from my review last year I have again researched how the Top 100 SMEs are funded in the current business environment. Figure 1 analyses the level of external debt reported on their latest balance sheet.

Some 53 of this year’s entrants are debt-free and operate from a cash positive position compared to 49 companies in 2010. Of the companies in a net debt position, 31 have borrowings of less than £2 million with a further 12 having between £2 million and £10 million. Only four companies in the survey reported more than £10 million of net debt, three of which are engaged in property investment.

Figure 2 shows the level of ‘gearing’ for the 47 companies that are in a net debt position compared to 51 companies with borrowings in 2010.

Gearing measures the extent of financial leverage in a company compared to its equity or shareholders’ funds total. It is important to consider gearing in context when appraising the financial position of a company – as a rule of thumb, a higher level of gearing would typically indicate a higher level of financial risk.

Some 33 of the of the 47 companies in a net debt position have gearing of less than 100 per cent and this compares to 29 in last year’s survey. Furthermore, only 14 companies in this year’s survey have gearing greater than 100 per cent compared to 22 companies in 2010.

In summary only 22 companies from this year’s survey have a gearing ratio of greater than 50 per cent compared to 32 companies in 2010. This reduction clearly demonstrates that successful management teams are working hard to take appropriate actions to put their businesses in a strong position. As a result they should be able to successfully operate through any further economic setbacks and also take advantage of any opportunities that may arise. To conclude, the results of this survey clearly highlight that the most profitable SMEs operate with low levels of gearing.