Gearing Ratio, Current Ratio and Working Capital Explained

0:00 Welcome back to the Money Minister podcast for South African retail investors who want to stop feeling like they are drowning in jargon and start navigating the market like someone actually knows what they're doing. I'm your host Jay, and today we're breaking down 3 balance sheet ratios that are more misunderstood than a tax return with miscellaneous income written on it. We talking gearing ratio, current ratio and working capital. The stuff that tells you if a company surviving swimming or about to drown in a puddle of it's own unpaid bulls. So let's start with gearing.

0:35 Most people hear the word and immediately think of cars, not companies. We not talking BMW's at this point in time. But in finance, gearing tells you how much of A company's operations are funded by debt versus equity. So let's get into a formula for gearing ratio. So if a company has 500 million in long term debt and 1 billion in equity, the gearing ratio is 500 divided by 1000 * 100. So that's 50%.

1:09 A 50% gearing ratio means their business is half funded by debt and half by shareholder capital. That's not necessarily a bad thing, but it is something to watch. So why does this matter? A high gearing above 60 or 70% means it's got higher financial risk. It means more repayments, more interest and more pressure when things go wrong. Think mining and construction capital heavy sectors where companies often borrow big to fund growth. So a company was too much gearing can be a little bit like a Golf.

1:43 GTI was broken clutch because it's really fast until it suddenly doesn't. Now let's talk current ratio. This one's about liquidity, how easily a company can pay its short term bulls. The formula for this one is quite simple. Current assets divided by current liabilities. Asia company has 200 million. The current assets will including cash, stock, accounts receivable and 100 million in current liabilities accounts payable, short term loans. Then 200 / 100 is 2 which means a ratio above 1 means the company has more short term assets than liabilities which is good a ratio below one.

2:29 That should be a red flag for you as I owe more than my own on the short term, but too high isn't good either. If a company has a ratio of five, you might want to ask why is all that cash just sitting there? Could it be invested or maybe return to shareholders? In retail this ratio is called. If you pick and pay has to pay suppliers faster than customers are buying groceries, they toast. In construction, well same thing. If the bulls for bricks are due before the client pays for the roof, well, you're in trouble.

3:05 Now let's chat working capital, the older cousin of the current ratio, this one's not a ratio, it's more a number. And the formula for that is current assets minus current liabilities. So if we use our early example, 200,000,000 -, 100 million = 100 million in working capital. Now you'll ask why does this matter or working capital is the fuel in the tank. It tells you if the company has enough short term assets to fund day-to-day operations now.

3:37 Fuel and no fire negative working capital means the company is robbing Peter to pay Paul. They need to pay 100 million in bills but only have 18 million in current assets. That's a bit of a Yikes over there. Retail companies usually run tight working capital cycles. Mixing ShopRite. They sell fast pay suppliers later that can actually work in their favour so long as the cash keeps flowing in.

4:03 But if consumers stop spending, their tightrope becomes a bit of a noose. So let's put it all together with some real South African spice. Imagine you looking at a construction company on the JSE. Let's just call it for now concrete and Co Gearing ratio of 75%. That means for every 1 Rand of their own money, they borrowing 3.

4:26 This oak loves death more than a politician loves a free lunch. Current ratio is .8. They owe more in the next 12 months than they have in liquid assets. This is a massive red flag. If a big client doesn't pay on time, they're going to sweat harder than the SAPS Commission at a corruption hearing. Working capital? Well that's negative. The liabilities outweigh their asset. It's like buying peers for the whole squad on credit and you look really cool until the bullet arrives. Would you invest in this business? Well, that's for you to decide, but you now know how to read the warning signs, so let's do some quick notes for interpretation. A low gearing ratio is safer but possibly slower growth. A high current ratio, safe but possibly inefficient. A positive working capital, well that's healthy, but we need some more context on that.

5:24 So none of these are stand alone. You've got to look at the business model, the industry and the economic climate. Mining gearing might be high, but long term project cycles make that acceptable. Retail tight working capital is normal as long as the stock turnover is strong. So in construction, well, all three of these ratios better be solid as hell will all the business will collapse faster than the sand fossil at high tide. So let's get to your stocks all started back of stock lingo for this volume 17 today we must defied gearing ratio. How much debt versus own capital accompany users current ratio or whether you can pay its short term bills or not working capital the actual buffer available for operations. So these tools help you judge a company's financial strength the same way a good Bolton buyer checks the colour, the spice and the fat content.

6:22 You'll not just looking at the label, you're feeling the weight. And while my jokes might be better geared than some Jazz Construction shares, remember this is not financial advice. Please do your own research and speak to a licensed financial advisor. Till next time, I'll see you back on the money mate.