3 + 4 Appraisal of Annual Reports Using Ratio Analysis Flashcards
What can ROCE be used for?
- indicates how successfully the management are using the funds provided to them from shareholders and debentures holders.
- It can help shareholders and providers of finance decide whether to invest in the company, by indicating how well funds provided in the past have been used (in terms of generating profits).
What is profitability?
gross profit and operating profit margins
What can ROCE figure achieved by as business be a result of?
profitability and/or efficient ultilisation of assets (net asset turnover)
What is ROCE?
Is the key ratio to how a company is performing this can be explained in isolation but is a product of a company’s profitability and efficiency
ROCE = Operating profit margin X net asset turnover
What does liquidity refer to?
the ability of a business to generate sufficient cash to pay its liabilities as they fall due
directly linked to the short term solvency of a business. A business will go bankrupt if it cannot pay its debts
What is working capital?
Current assets- Current liabilities
What is working capital management?
- not holding too much inventory for too long,
- good collection policy on trade receivables
- prompt payment of trade payables
- Inadequate and inefficient working capital policies may lead to an overdraft which is an expensive form of finance
What is the working capital cycle?
cash > purchase inputs > production > inventories > sales > trade recievables > cash
What does ROCE stand for?
Return on capital employed
How can ROCE be calculated?
operating profit/(equity funds + non current liabilities)
What is efficient utilisation of assets?
net asset turnover
How is gross profit margin calculated?
(gross profit / turnover) * 100
How is operating profit margin calculated?
(operating profit / turnover) * 100
What does operating profit include?
cost of sales, administration and distribution costs
How is net asset turnover calculated?
turnover / (equity + non-current liabilities)
What can the net asset turnover figure be used for?
can be compared over time and against companies in the same industry to assess if management are utilising the resources at there disposal to generate revenue
What is liquidity?
refers to the ability of a business to generate sufficient cash to pay its liabilities as they fall due.
Directly linked to the short term solvency of a business.
What are examples of current assets?
Inventory
Trade receivables
Cash
What are examples of current liabilities?
Trade payables
Tax payable
Overdraft
How is the current ratio calculated?
current assets / current liabilities
Is a high current ratio good?
Too high a ratio can mean inefficiency a company should not hold large reserves of cash.
The cash should be invested and generating profits
What is the acid test ratio?
(current assets - inventory) / current liabilities
Why remove inventory in the acid test ratio?
The time lag of turning inventory into cash
inventory > trade receivable > cash
How is the inventory holding period?
( closing inventory / cost of sales) *365
How is the collection period calculated?
(trade receivable / revenue) * 365
What is the problem if the collection period is too long?
may indicate poor collection policy.
Or unsatisfied customers who are refusing to pay, poor quality product.
What is the problem if the collection period is too short?
may lose customers to competitors who offer better credit terms
Or may be offering discount for prompt payment which will effect margins.
How is the payment period calculated?
(trade payables / cost of sales) * 365
Is a long payment period good?
If pay on a timely basis may receive discount which will help with profitability compared to competitors.
If too high may have a poor relationship with suppliers which could effect future supplies and prices.
What is the risk to investors?
Investors face a risk of not receiving an annual return on their investment and also not having their investment repaid.
How can solvency of a business can be assessed?
by looking at its gearing
What is financial gearing?
looks at how the company is financed.
What is debt also known as?
non-current liabilities
What is equity?
Ordinary share capital plus the reserves. `
How is gearing calculated?
debt to equity ratio
debt/equity = (loans + overdrafts) / (share capital + reserves)
How is the interest cover?
operating profit / interest payable
What is the impact of gearing?
It can be seen that a highly geared firm has a greater financial risk. This is because the interest charge is fixed and must be repaid no matter what the level of profit or loss.
