21. The interpretation of financial statements

Question 1

Ratios

Answer 1

comparison of one figure with another

Question 2

Using ratios

Answer 2

Comparison is commonly made with;
previous accounting periods
other companies
budgets and forecasts
government stats
other ratios

Question 3

Types of ratios

Answer 3

profitability ratios (performance)
liquidity (solvency)
efficiency
capital structure (gearing)
security (investors)

Question 4

Gross profit margin

Answer 4

gross profit / sales

Question 5

Gross profit mark up

Answer 5

gross profit / cost of sales

Question 6

Operating profit margin

Answer 6

operating profit/ sales

Question 7

Capital employed

Answer 7

equity + non current liabilities

or just equity

Question 8

ROCE (return on capital employed)

Answer 8

Operating profit / average capital employed

Question 9

Average capital employed

Answer 9

closing total capital employed
+ opening total capital employed
/ 2

Question 10

ROE (return on equity)

Answer 10

profit for the period / average equity

Question 11

Average equity

Answer 11

closing equity
+ opening equity
/ 2

Question 12

net asset turnover

Answer 12

sales revenue / capital employed

= times per annum

Question 13

Relationship between ratios

Answer 13

operating margin x asset turnover = ROCE
operating profit sales revenue = operating profit
/ /
sales revenue x capital employed = capital employed

Question 14

Current ratio/ working capital ratio

Answer 14

current assets / current liabilities

i.e. 8.9:1 = for every £1 owed the business has £8.9 in assets to pay the debt = GOOD

Question 15

Quick ratio/ acid test ratio

Answer 15

current assets excluding inventories
/
current liabilities

420/ 420 = 1 = ideal

Question 16

sales : non current assets

Answer 16

sales
/
non current assets
tells us how much sales are derived from the non current assets in the business

Question 17

Inventory days

Answer 17

inventory
/
cost of sales
x 365

how long is it taking us to sell out inventory

Question 18

Average inventory

Answer 18

opening inventory
+ closing inventory
/ 2

Question 19

Receivables days

Answer 19

receivables / sales x 365

Question 20

Payable days

Answer 20

payables / purchases x 365

Question 21

Total working capital ratio

Answer 21

Number of inventory days
+ number of receivable days
- number of payable days
= total working capital days

Question 22

Gearing ratio

Answer 22

debt
/
total capital employed
x 100

Question 23

Interest cover

Answer 23

operating profit
/
interest payable