OT22095 - Interest and Financing

Gearing. Composition and Character of Equity.

In considering debt:equity ratios the following are accepted as contributing to the positive equity of a company:

Issued share capital

Interest free debt*

Capital contributions*

Share premium account

Surplus of retained profits

(*so long as the company agrees they may not be withdrawn or distributed)

Reserves previously made in the accounts but written back to profit and loss account as no longer necessary may be part of the equity, but it would depend on the particular circumstances.

The following are not considered to be equity. Properly computed they represent true liabilities of the company which are therefore not available to meet other calls on their funds:

Tax reserves, whether current or deferred

Abandonment reserves

Equity should also be regarded as reduced by:

Negative balance on profit and loss account, i.e. a balance of retained loss

Interest free loans made by the company

In addition, investments in subsidiaries or associates by way of share capital, interest free loans or capital contributions may reduce equity and need to be considered in the light of the particular circumstances.

If the balance on profit and loss account is accepted as equity it would be normal for the lender to seek a negative pledge that the borrower should not take any action to reduce the level of retained profits below a specified level