17. Interpretation of Financial Statements Flashcards
What comparatives might we use when assessing company performance?
Prior periods, budgets, competitors and industry averages
What are the 5 ratios of profitability?
- Gross Profit Margin
- Operating Profit Margin
- Net Profit Margi
- Return on Capital Employed
- Asset Turnover
Who is interested in profitability ratios?
Investors (shareholders) and management
What are the 5 ratios of liquidity?
- Current ratio
- Quick ratio (acid test)
- Receivables collection period
- Payables collection period
- Inventory turnover
Who is interested in liquidity ratios?
Creditors and investors
What are the 2 risk ratios?
- Gearing
2. Interest cover
Who is interested in risk ratios?
Creditors and investors
What is a companies working capital?
Net current assets –> Inventories + receivables - payables
What is the formula for gross profit margin?
Gross Profit / Revenue
What is gross profit margin used for?
To make pricing decisions
What might cause fall in gross profit margin?
Increased costs or reduced prices to buy market share
Is gross profit margin affected by volume of sales?
No
What is the formula for operating profit margin?
(Operating Profit (Before Interest and Tax))/Revenue
What is the formula for net profit margin?
(Net Profit (Before Tax))/Revenue
What do the profit margin ratios help to show?
How efficiently the business is being run
What is the formula for asset turnover?
Revenue/(Total assets - current liabilities)
OR
Revenue/(Share capital + Reserves + NCL)
What does asset turnover measure?
How much sales revenue is generated for every £ of net assets employed - are they working efficiently and have they improved performance
What is the formula for non current asset turnover?
Revenue/NCA
What is the formula for Return on Capital Employed?
(Profit before interest and tax)/(Total assets - current liabilities)
OR
(Profit before interest and tax)/(Share capital + Reserves + NCL)
Why is ROCE called the primary ratio?
It is the only ratio which compares profits to the overall size of the business
What is an alternative equation for ROCE?
Operating Profit Margin x Net Asset Turnover
Order current assets from most to least liquid:
Cash, Receivables, Inventory
What is the calculation for Working Capital?
Current Assets - Current Liabilities
What is the current ratio?
Current Assets/Current Liabilities
What does the current ratio measure?
How easily a company can meet its current obligations
What value of the current ratio would be a cause for concern?
Less than one - CL > CA, cannot meet obligations as they fall due
What is the quick ratio?
(Current Assets - Inventory)/Current liabilities
What is the formula for receivables collection period?
(Average trade receivables)/Credit Sales x 365
What is the formula for payables payment period?
(Average trade payables)/(Credit Purchases or COS) x 365
What is the formula for inventory days?
Inventory/COS x 365
What is the formula for inventory turnover?
COS/Inventories
What is the formula for the operating (or cash) cycle?
Inventory days + Receivables days - Payables Days
What is high gearing?
A company has a high proportion of borrowing (loans) compared to equity
What is low gearing?
A company has a high proportion of equity compared to borrowing?
What is the gearing ratio?
(Interest bearing debt (excl. overdrafts but inc preference shares)) / (Share Capital + Reserves - NCL)
What is the advantage of high gearing?
Debt is cheaper than equity (interest is fixed and tax deductible)
What is the disadvantage of high gearing?
Harder to raise extra finance (from lenders or new shareholders)
What is the formula for interest cover?
(Profit before interest and tax)/(Interest/finance Costs)
