3.5.2 Ratio Analysis Flashcards
1
Q
Gearing
A
Measures the proportion of a businesses capital provided by debt.
2
Q
Gearing ratio
A
Non-current liabilities/Total equity+Non-current liabilities x 100
50% + is high.
20% is low.
3
Q
Why is gearing useful?
A
- Measure of the financial health of a business.
- Focuses on the level of debt in the financial structure of a business.
- High gearing can mean high business risk.
4
Q
Benefits of high gearing
A
- Less capital required to be invested by shareholders.
- Debt can be a relatively cheap source of finance compared with dividends.
- Easy to pay interest if profits and cash flow are strong.
5
Q
Benefits of low gearing
A
- Less risk of defaulting on debts.
- Less exposed to interest rate changes.
- Shareholders rather than debt providers have influence over business.
- Business has the capacity to add debt if required.
6
Q
Return on capital employed
A
The % return a business makes on an investment decision.
7
Q
Return on capital employed formula
A
Operating profit/Total equity + Non-current liabilities x 100
8
Q
Why is return on capital employed useful?
A
- Evaluate the overall performance of the business.
- Provide a target return for individual projects.
- Benchmark performance with competitors.
9
Q
Benefits of ratio analysis
A
- Measures performance and can spot and compare trends over time.
- Compare ratios with other firms.
- Can be used to make business decisions - managers, lenders and shareholders.
10
Q
Limitations of ratio analysis
A
- Doesn’t take into account qualitative factors such as brand image or customer service.
- External factors such as the Economic climate or performance of other businesses aren’t taken into account.
- Doesn’t take into account the impact of long-term decisions, such as investments today that may lower profitability in the short term but boost it in the long term.
- Financial accounts are a snapshot of a firms finances on a given day, may not be representative of its usual circumstances.
