13) UNIT 2 - Ratio Analysis Flashcards
list the types of ratio’s
- profitability
- liquidity
- efficiency - ROCE
Advanatges of ratio analysis
- used to gain further analysis of financial accounts. for example a business may have more sales but profitability ratio can be used to see if they are making a good percentage return (sales may have went up but gross profit % went down, due to expenses involved in making the product)
- Liquidity ratios - see if the business has enough current assets to pay off short term liabilities, which indicates ability to pay off debts
- help compare current performance with previous years
- help compare performance with similar competitors
- monitor and identify issues that can be highlighted and resolved e.g is ratio less than 2:1 then they may not be able to pay off debts
- used to give managers targets to work towards based on the current years performance
name and describe the limitation/disadvantages of financial information/ ratio analysis
1) Information is historical:
•information changes all the time e.g statement of financial position will change by next day
•cannot always base future decisions on past performance
2) Does not take into account external factors
•such as state of economy social trends, all that affect a business
•e.g. brexit not shown in financial info
3) Does not show new product or product development in process
•which can be beneficial to business
4) Differences in accounting procedures
•not every business will use the same structure which will cause variation of financial information
•e.g. accountants will use various methods to calculate the value of assets
5) some assets are difficult to value
•e.g ‘customer loyalty’ cannot be valued in a financial statement but is very valuable for businesses such as hair dressers
6) Can only compare like to like e.g. a small business to another small business
name and describe the purpose the types of the different profitability ratio
- gross profit %: measures the percentage profit made on trading activities only
- profit of the year %: measures the percentage net profit made on selling goods and services, when all expenses have been taken into account
- profit mark up %: measures the percentage that was added to the costs of goods to calculate the selling price
- Return on capital employed (ROCE): measures the percentage return on the owners capital invested in the business
identify improvements for each of these ratios:
- gross profit %
- profit of the year %
- profit mark up %
- return on capital employed (ROCE)
Gross profit %:
•cut on cost of production
•purchasing cheaper goods
•increase the selling price to consumers
Profit of the Year %:
•negotiate prices with suppliers
•fixed plans with gas/electric
•higher selling price
Profit Mark Up%:
•cutting the costs of production
•purchasing cheaper goods
•increase selling price
ROCE:
•fixed price plans for gas and electric
•purchasing cheaper goods
•increasing selling prices
name and give the purpose of the 2 liquidity ratios
current ratio: measures the proportion of current assets to current liabilities
acid test ratio: measures the proportion of current assets to current liabilities
list the users of financial information
- owners/shareholders
- managers
- employees
- trade union
- creditors
- government
- investors/potential investors
- customers
describe how owners are interested in financial information/ratios
(3 pts)
- evaluate performance in all areas if the business and see what decisions have been effective
- see if they are making good return on their investment
- see if the business needs more investment
describe how managers are interested in financial information/ratios
(3 pts)
- evaluate performance in all areas of the business and see what decisions have been effective
- identify problems/weaknesses in the business such a liquidity and take corrective action
- to allow planing and helps in decision making
describe how employees are interested in financial information/ratios
(1 pt)
•interested in the financial situation of the business, particularly liquidity and profitability as this affects their job security, pay and bonuses
describe how trade unions are interested in financial information/ratios
(1 pts)
•interested in the financial situation of a business particularly liquidity and profitability as this can affect pay and working conditions of workers they represent
describe how creditors are interested in financial information/ratios
(1 pt)
•interested in mainly liquidity as this indicates how able the business is to pay off short term debts
describe how the government is interested in financial information/ratios
(2 pt)
- interested to see if the legal obligation of preparing financial statements have been met
- Inland Revenue want accurate information to calculate taxation
describe how potential investors/ investors are interested in financial information/ ratios
(1 pt)
•interested to see how well the business is doing in profitability/ ROCE to determine if it a worthwhile investment
describe how customers are interested in financial information/ ratios
(2 pts)
- Interested in if the business is being ethical in its financial decisions
- interested in the financial situation of the business as that can affect unemployment in their area
