3.3.3 Financial ratios Flashcards
What are Financial ratios?
Financial ratios are calculations that help managers examine the performance of the business and determine if the business is meeting its financial objectives.
how does the analysis of financial statements through financial ratios help a business?
Analysis of financial statements through financial ratios helps identify trends and make predictions and assists future planning and the development of corrective strategies
What type of financial ratios are there in business studies?
- Liquidity- current ratio
- Gearing- debt to equity ratio
- Profitability- gross profit ratio, net profit ratio, return on owners equity
- efficiency- expense ratio, accounts receivable turnover ratio
What type of ratio is required to calculate liquidity?
Current ratio
Current Assets divided by Current liabilities
Why is current ratio used to calculate Liquidity?
The ratio gives an indication of how well the business can meet is current liabilities from its current assets
The generally preferred ratio level is 2:1. Meaning for every $2 of current assets there is 1$ of current liabilities
What type of ratio is required to calculate Gearing?
Debt to equity ratio
Total liabilities
——————— x 100 divided by one
Total equity
Why is Debt to equity ratio used to calculated gearing?
Gearing is the relationship between the level of debt of the business and the level of total equity. If a business is highly heard it faces the possibility of not being able to repay its debt and becoming insolvent.
For small business 60% is an acceptable level for every 60cents of liability there is 1$ of total equity.
What is the financial ratio for profitability
Return on equity (solid one)
Net profit divided by total equity times 100
Net profit ratio
Return on equity
Why is Return on equity used to calculate profitability?
This is one of the most important indicators as it shows how much the owners’ investment and risk in the business is earning
A high % is preferred but it depends on the industry. 20% is usually a good return
What financial ratio is used for efficiency?
Accounts receivable turnover
1. credit sales divided by accounts receivable= results
365 divided by results = days
Expense ratio
Why is the accounts receivable ratio used to calculate efficiency
This ratio shows how long it takes for the business to receive cash for its credit sales form the debtors
The standard time to repay credit is between 14 and 30 days.
