3.5.2 - RATIO ANALYSIS

Question 1

What is GEARING RATIOS

Answer 1

show the LONG TERM FINANCIAL POSITION POSITION of the BUSINESS

show the RELATIONSHIP between LOANS on Which INTEREST is PAID and SHAREHOLDERS EQUITY on which DIVIDENDS might be PAID

lower = better

Question 2

What is GEARING RATIO FORMULA

Answer 2

(NON-CURRENT LIABILITIES / CAPITAL EMPLOYED) x100

Question 3

How can GEARING RATIOs be USED

Answer 3

• USED to ANALYSE the CAPITAL STRUCTURE of a BUSINESS
• can ASSES WHETHER o NOT a BUSINESS is BRANDED BY its LOANS
  is BECAUSE HIGHLY GEARED COMPANIES must STILL PAY their INTEREST even when Trading Becomes Difficult

Question 4

What is RETURN on CAPITAL EMPLOYED

Answer 4

the PROFIT of a BUSINESS as a PERCENTAGE of the TOTAL AMOUNT of MONEY USED to GENERATE IT
-> EFFICIENCY of ASSETS

Question 5

What is the FORMULA of RETURN on CAPITAL EMPLOYED

Answer 5

(OPERATING PROFIT / CAPITAL EMPLOYED) x100

the Higher Value the Better

Question 6

What is CAPITAL EMPLOYED

Answer 6

the TOTAL WORK of a BUSINESS - ASSETS - VALUE of EVERYTHING OWNED

Question 7

What is the FORMULA of CAPITAL EMPLOYED

Answer 7

TOTAL EQUITY + NON-CURRENT LIABILITIES
or
TOTAL ASSETS - CURRENT LIABILITIES

Question 8

What are 2 LIMITATIONS of RATIO ANALYSIS

Answer 8

• QUALITY OF FINAL AMOUNTS : Ratio’s are Based on Financial Accounts, e.g. Balance Sheets and Income Statements. Ratio’s are Only Useful If the Accounts are Accurate
• QUALITY OF INFORMATION IS IGNORED : Ratios Only use Quantitative Information. However, Some Important Qualitative Factors May Affect a Performance of a Business that are Ignored by Ratio Analysis
• WINDOW DRESSING : businesses Can Manipulate their Accounts Legaly to Present Different Financial Pictures