21 - Interpreting company accounts Flashcards
what is the purpose of interpreting ratios in a business environment
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
who use financial statements the most
the main providers of finance are the most important users
investors use them to assess profit generated and performance
what is profitability
measures the relationship between income and expenses and profit or losses measured against investment in the business
what is liquidity
focuses on relationship between assets and liabilities and ability of company to settle its obligations as they fall due
what is risk
analyses the long term financial stability of the company
how important are ratios
they compare one figure with another
on their own, have minimal impact so they must be compared with other data
what are some comparisons that ratio can be used for
- previous years financial statements (gross profit margin better or worse?)
- budgeted financial statements (gross profit higher or lower than forecast?)
- financial statements of another company (gross profit margin stronger/weaker than competitor?)
- average figures for the industry (how profitable is company compared to industry as whole?)
what does gross profit margin show
measures how well a company is running its core operations
what is gross profit margin formula
gross profit / revenue x 100 = X%
what factors cause a gross profit margin to vary
- 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)
what is the formula for operating profit margin
profit from operations / revenue x 100 = x%
what is profit from operations
= profit before finance charges and tax (PBIT, profit before interest and tax)
difference between operating margin and gross profit margin
the operating profit shows how well the company is controlling its overheads
why does operating profit margin vary
- one off non-recurring expenses
- rapid expansion
- efficiency savings (economies of scale)
what is the net profit margin formula
profit for the year / revenue x 100 = x%
net profit margin implications from business finances
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
return on capital employed formula
profit from operations / total equity + non current liabilities
X 100 = x%
what does return on capital employed show
profit in relation to capital employed to generate profit
measures how efficiently a company uses its capital to generate profits
how does return on capital employed change
IMPROVES
if profits from operations increase, or capital employed remains unchanged
DECREASES
if profit from operations remains the same, and capital employed increases
non current asset turnover formula
revenue / non current assets = x times
what does non current asset turnover mean
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
how does non current asset turnover change and what causes it to change
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
current ratio (working capital ratio) formula
= current assets / current liabilities = x:1
what does current ratio (working capital ratio) measure
measures the relationship between current assets and current liabilities on the statement of financial position
