3.5.2 - Ratio Analysis

Question 1

3 main classification ratios

Answer 1

Profitability, liquidity, gearing

Question 2

Profitability shows

Answer 2

The relationship between gross/operating/ net profit and revenue, assets and capital

Question 3

Liquidity shows

Answer 3

Shows the ability of a firm to meet its short term debts with cash or near cash equivalents

Question 4

Gearing shows

Answer 4

The proportion of the long term finance in a business that has come from loans

Question 5

Current ratio formula

Answer 5

(Current assets/ current liabilities)

Question 6

Ideal value current ratio

Answer 6

1.5

Question 7

Formula acid test ratio

Answer 7

(Current assets(excluding stock)/ current liabilities)

Question 8

Ideal value acid test ratio

Answer 8

1

Question 9

Gearing measures

Answer 9

Long term financial health of the business

Question 10

Gearing ratio formula

Answer 10

Long term liabilities/ capital employed x 100

Question 11

Ideal gearing ratio

Answer 11

Low

Question 12

What does gearing ratio express

Answer 12

Long term liabilities as a percentage of the total amount of long term capital in the business

Question 13

3 ways to reduce unhealthy high gearing ratios

Answer 13

Issue more shares, retain more profits, repay loans

Question 14

How to improve gross profit margin

Answer 14

Price up, unit variable costs down

Question 15

Problems occurring with gross profit margin

Answer 15

May not be enough gross profit to cover all overhead expenses

Question 16

How to improve operating profit margin

Answer 16

Boost gross margin, cut overheads

Question 17

Problems of operating profit margin

Answer 17

Not enough operating profit to reinvest into business, unable to achieve growth

Question 18

How to improve NPV

Answer 18

Boost operating profits margins, cut corporation tax bill

Question 19

Problems of NPV

Answer 19

May be too low to provide shareholders with acceptable dividends

Question 20

ROCE formula

Answer 20

Operating profit/ capital employed x 100

Question 21

What is a food ROCE ration

Answer 21

The higher the better since returns means more money is invested into the business

Question 22

2 ways to boost ROYCE

Answer 22

Find a way to increase operating profit

Reduce capital employed without damaging operating profit

Question 23

Limitations of ratio analysis

Answer 23

• lack of detail provided with financial accounts
• firms true stock and receivables can’t be seen
• easy for acid test to be misleading eg debt from failing customers
• if stock is going out of fashion worthless, misleading current ratio
• net profit can affect one off transactions