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3. BA3 CIMA > 21 - Interpreting company accounts > Flashcards

21 - Interpreting company accounts Flashcards

1
Q

what is the purpose of interpreting ratios in a business environment

A

stakeholders use financial statements to make decisions

ratio analysis enables better understanding and interpretation of accounts

ratios calculated depend on needs of users and must be made on a year to year basis

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2
Q

who use financial statements the most

A

the main providers of finance are the most important users

investors use them to assess profit generated and performance

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3
Q

what is profitability

A

measures the relationship between income and expenses and profit or losses measured against investment in the business

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4
Q

what is liquidity

A

focuses on relationship between assets and liabilities and ability of company to settle its obligations as they fall due

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5
Q

what is risk

A

analyses the long term financial stability of the company

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6
Q

how important are ratios

A

they compare one figure with another

on their own, have minimal impact so they must be compared with other data

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7
Q

what are some comparisons that ratio can be used for

A
  1. previous years financial statements (gross profit margin better or worse?)
  2. budgeted financial statements (gross profit higher or lower than forecast?)
  3. financial statements of another company (gross profit margin stronger/weaker than competitor?)
  4. average figures for the industry (how profitable is company compared to industry as whole?)
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8
Q

what does gross profit margin show

A

measures how well a company is running its core operations

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9
Q

what is gross profit margin formula

A

gross profit / revenue x 100 = X%

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10
Q

what factors cause a gross profit margin to vary

A
  • change in sales price
  • change in sales mix (eg selling higher markup items)
  • change in purchase price or production costs (eg from discounts or efficiencies)
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11
Q

what is the formula for operating profit margin

A

profit from operations / revenue x 100 = x%

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12
Q

what is profit from operations

A

= profit before finance charges and tax (PBIT, profit before interest and tax)

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13
Q

difference between operating margin and gross profit margin

A

the operating profit shows how well the company is controlling its overheads

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14
Q

why does operating profit margin vary

A
  • one off non-recurring expenses
  • rapid expansion
  • efficiency savings (economies of scale)
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15
Q

what is the net profit margin formula

A

profit for the year / revenue x 100 = x%

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16
Q

net profit margin implications from business finances

A

net profit margin is higher for a business mainly financed by equity investment (interest is lower)

relative to a company with significant borrowings and a similar operating profit margin

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17
Q

return on capital employed formula

A

profit from operations / total equity + non current liabilities
X 100 = x%

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18
Q

what does return on capital employed show

A

profit in relation to capital employed to generate profit

measures how efficiently a company uses its capital to generate profits

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19
Q

how does return on capital employed change

A

IMPROVES
if profits from operations increase, or capital employed remains unchanged

DECREASES
if profit from operations remains the same, and capital employed increases

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20
Q

non current asset turnover formula

A

revenue / non current assets = x times

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21
Q

what does non current asset turnover mean

A

this ratio measures productivity of non current assets in generating revenue

assessment of no of dollars/pounds of revenue generated per dollar of non current assets employed by the company

22
Q

how does non current asset turnover change and what causes it to change

A

where non current assets have been purchased, ideally non current asset turnover ratio will increase

if assets are acquired late in the year, they may not have had sufficient time to create revenue = ratio will fall

23
Q

current ratio (working capital ratio) formula

A

= current assets / current liabilities = x:1

24
Q

what does current ratio (working capital ratio) measure

A

measures the relationship between current assets and current liabilities on the statement of financial position

25
Q

how can current ratio (working capital ratio) be utilised

A

a company shouldn’t operate at a level too low - it won’t have enough assets to cover debt

a company also shouldn’t operate at level too high - increases working capital required by the business

26
Q

why does current ratio (working capital ratio) increase or decrease

A

INCREASE
if current assets increase in proportion to current liabilities

DECREASE
if current liabilities increase in proportion to current assets

27
Q

how may industry affect current ratio (working capital ratio)

A

supermarkets have lower current ratio relative to other businesses

this is because they have low receivables, low inventory and high payables

28
Q

quick ratio (acid test ratio) formula

A

current assets - inventories / current liabilities = x:1

29
Q

how is quick ratio (acid test ratio) different from current ratio

A

it excludes the inventories figure from current assets because they are highly illiquid

quick ratio is more reliable measure of liquidity bc businesses wont be able to use inventories to pay off payables quickly

30
Q

inventory turnover formula

A

cost of sales / inventories = x times

31
Q

what does inventory turnover show

A

shows on average how many times a company is able to sell its inventory in a year

32
Q

what is the ideal level of inventory turnover

A

most aim to keep it high as this means stock flows through the warehouse at a reasonable rate = reduces risk of obsolete stock

33
Q

what is the trade receivables collection period days formula

A

average trade receivables / revenue x 365 = x days

34
Q

what does trade receivables collection period days show

A

this ratio shows how long it takes credit customers to settle the amount owed to the business

the collection period should be compared to previous yr

35
Q

how does trade receivables collection period change

A

trade receivables collection period will increase where credit customers are taking longer to settle the amount owed to the business

36
Q

how is average trade receivables in trade receivables collection period formula calculated

A

calculated by taking opening and closing trade receivables balances and dividing by two to obtain the average figure

37
Q

what is the formula for trade payables payment period (days)

A

average trade payables / cost of sales x 365 = X days

38
Q

what does trade payables payment period (days) measure

A

measures the average time it takes the business to settle amounts owed to credit suppliers

39
Q

how does trade payables payment period (days) change

A

may increase when a business delays paying credit suppliers, indicating cash flow issues

40
Q

how is average trade payables calculated for trade payables payment period (days) formula

A

taking the opening and closing trade payables balances and dividing by two to obtain average

41
Q

inventory period (days) formula

A

average inventory / cost of sales x 365 = X days

42
Q

what does inventory period (days) indicate

A

indicates the average number of days that items of inventory are held for

43
Q

what does the level of inventory period (days) show and how does it change

A

increasing inventory days from one year to next = indicates slow down in trading

the lower the inventory days, the better but this needs to be balanced with factors like expected volume of customer orders and bulk buying discounts

44
Q

how is average inventory obtained for inventory period (days) formula

A

takes opening and closing inventory balances and dividing by two

45
Q

what does the length of the working capital cycle indicate

A

working capital cycle has to be financed

the longer the cycle = the more financing required and higher risk of insolvency

so it is important for businesses to have short inventory days and receivables collection periods, and longer payables payment periods

46
Q

what is the formula for gearing

A

non current liabilities / total equity + non current liabilities
x 100 = x%

47
Q

what is gearing and what does it measure

A

is concerned with the long term financial stability of the company

the process of looking at how much the company is financed by debt

48
Q

what does the level of gearing indicate

A

the higher the gearing ratio, the less secure the financing of the company and possibly companys future

gearing increases when companys loan finance increases by more than equity finance

49
Q

what is the formula for interest cover

A

profit from operations / finance costs = x times

50
Q

what does interest cover show

A

interest cover ratio considers no of times a company could pay its interest payments using profits from operations

51
Q

why might interest cover change

A

where profit from operations rises and interest charges are unchanged, interest cover increases because there is additional profit to cover interest charges

52
Q

working capital cycle formula

A

inventory period (days) + receivables collection period (days) - payables payment period (days)

3. BA3 CIMA (23 decks)

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