3.5.2 Ratio Analysis

Question 1

What is return of capital employed ratio

Answer 1

This Ratio compares operating profit earned with the amount of capital employed by the business. Includes total equity and non current liabilities

Question 2

Why is it important to know return of capital employed

Answer 2

Shows how effectively the business was able to generate profit from the investment placed within the business,

-can be compared to previous years and general rate of interest

Question 3

How do you calculate return on capital employed

Answer 3

Operating profit
————————— x 100
Capital employed

Question 4

What is gearing ratio

Answer 4

Gearing analyses how a business has raised it long term finances, represents proportion of a firms equity that is borrowed

Question 5

How do you interpret gearing ratio

Answer 5

If a business has a high gearing ratios it means that they are vulnerable to increase in interest rates
When it is low they can afford to borrow funds to expand

Question 6

How do you calculate gearing ratio

Answer 6

Non current liabilities
——————————— x 100
Total equity + non current liabilities

Question 7

What are some benefits of ratio analyses

Answer 7

• allows a business to calculate and compare trends over time
• shows greater insight to financial accounts
• information can be used to benchmark data
• helps assess performances of other functional areas of the business

Question 8

What are some drawbacks of ratio analysis

Answer 8

Does not take qualitative issues such as brand image or customer service performance

• does not take into account long term business decisions
• doesn’t include economic climate and how they may affect the business