20. Interpretation of Financial Statements Flashcards
Formula for gross profit margin?
What does it measure?
What might change it?
Gross profit / sales revenue x 100
Measures profitability
Effected by changes in primary costs
If GPM does not increase in line with sales revenue, why might this be? (3)
- increased purchases
- increased write offs
- additional cost of sales
Formula for operating profit margin
What does this measure?
What might change this but not GPM?
Profit before finance charges and tax/sales revenue x 100
Measures management’s capability in terms of profitability
Charges of depreciation, changes in rent, write offs of irrecoverable debts, changed in employment, high ad costs etc.
Formula for ROCE?
What does this show?
What might you compare a ROCE score with? (3) I
operating profit/capital employed x 100
Capital employed = total assets - current liabilities OR equity + interest bearing finance
Shows profits per £ invested
Compare with previous year ROCE; target ROCE or another companies ROCE.
Net asset turnover formula:
What does it measure?
What can it further be broken down into?
Sales revenue/capital employed = times pa
Sales per £ invested so measures management’s efficiency in generating revenue
Non-current asset turnover = sales revenue/non current assets
Working capital turnover = sales revenue/net current assets
What are ROCE and net asset turnover easily skewed by?
Investment costs: makes these appear low when returns will not be felt until the future
What is the formula for current ratio?
What does this measure?
What is the ideal score?
A high current ratio may indicate…
Current assets / current liabilities : 1
Measures a businesses ability to pay current liabilities
Ideal is 1.5:1 (used to be 2:1)
- high levels of inventory: unsellable or weak credit control
- high levels of cash - why aren’t they investing it?
What is the formula for quick ratio?
How does this differ from current ratios?
What is the ideal range?
What would you class as quick assets and quick liabilities?
Current assets - inventory / current liabilities : 1
Considers what liabilities could be paid with liquid assets
Ideal range is 1:1 to 0.7:1
Assets: bank, cash n receivables
Liabilities: overdrafts, payables n tax (not income) and social security dividends
Formula for inventory turnover period?
What does this measure?
What might this mean?
Inventory / cost of sales x 365 = X days
How long inventory is stored for before it is sold
- unsellable inventory
- poor credit control
OR - expected increase in sales
- bulk buying cash discount
- avoiding stock out
Formula for receivables collection period:
What does this show?
What might you compare this to?
What does it mean?
What can it be distorted by?
Receivables / credit sales x 365 = X days
Shows average time taken to collect cash from customers
Compare to previous years, credit policy and competitors
Usually signals bad credit BUT
- may be deliberately high to attract customers
May be distorted by
- using year end figures
- sales on unusually long credit terms
Formula for payables payment period
What does this mean?
What might be reasons for a long payment period?
What are the consequences of a long payment period?
Payables / credit purchases x 365 = X days
How long it takes to pay debts
May be due to free finance or liquidity problems
Consequences include:
- poor reputation
- stricter terms in future
- loss of cash discounts
What is the cash cycle?
How do we calculate the cash conversion cycle?
Ensures businesses has adequate cash resources
= Inventory period + receivables period - payables period
What is gearing?
How do we measure it?
Assesses business stability and exposure to risk expressed as external debt against equity finance.
High gearing = higher debt than equity - cheaper but riskier
Debt/equity ration = long term debt / equity
% of capital employed = long term debt / equity + long term debt
What is interest cover?
How do we calculate it?
Reveals ability to pay finance charges
Profit before tax / interest payable
Below two - signs of issues.
