3.5.2 ratio analysis

Question 1

describe ratio analysis

Answer 1

Allows for a more meaningful analysis of published accounts
Shows relationship between figures
Used for comparisons over time

Question 2

what are Inter and intra business comparisons

Answer 2

Intra means between businesses e.g. to compare performance to competitors or to benchmark
Inter means within a business e.g. over time within one organisation or between branches

Question 3

ratio analysis Gearing (%) measure

Answer 3

Measures what proportion of a business’ capital is funded through long term loans
Loans are “compulsory interest bearing” i.e. you have to pay interest on them even if profits are low or non-existent
A highly geared business is of greater risk if interest rates are likely to increase

Question 4

ratio analysis Gearing (% formula

Answer 4

Non-current liabilities/Total equity + non-current liabilities x100

Question 5

Ratio Analysis - Profitability

Return on Capital Employed (ROCE) measure

Answer 5

A measure of how efficiently a business is using capital employed to generate profits

Question 6

capital employed formula

Answer 6

Capital employed = total equity + non-current liabilities

liabilities i.e. all the money invested in the business from:
Share capital
Reserves
Long term loans

Question 7

Ratio Analysis - Profitability

Return on Capital Employed (ROCE formula

Answer 7

Operating profit / Total equity + non-current liabilities x100

Question 8

Interpret ratios to make business decisions

gearing

Answer 8

How to finance future strategies
Risk of rising interest rates
Negotiating credit terms with suppliers
Rewards to be paid to shareholders based on their levels of risk
Set investment criteria
Strategic direction

Question 9

Interpret ratios to make business decisions

Return on capital employed

Answer 9

Managers’ financial rewards
Efficiency targets - identify training needs
Future investments
Disposal or purchase of non-current assets
Capacity utilisation targets

Question 10

Values and limitations of financial ratios when assessing performance

Answer 10

values

Provides a tool for the interpretation of accounts

Structure from which comparisons can be made

• Overtime
• With other businesses

Aids decision making

• Internally
• Externally by investors

limitations

Possibility that accounts have been window dressed

Need to consider reasons behind ratios
-e.g. is ROCE lower than previous years because of an investment programme

Quantitative information only