3.5.2 Ratio analysis Flashcards
How do you work out R.O.CE?
(Operating Profit) / (Capital Employed) x100
How do you work out capital employed?
(Non-current Liabilities + total equity)
How do you work out total equity?
share capital + retained profit
What is R.O.C.E?
Return on Capital Employed
What does R.O.C.E allow you to measure?
It helps you evaluate the overall performance of the business.
What can you do with R.O.C.E?
- Set targets
- compare performance with the competition
What does Return on capital employed mean?
Also known as the primary ratio, It tells us what returns (profits) the business has made on the resources available to it.
What is capital employed?
a measure of the total resources that a business has available.
What is the ideal value of ROCE?
As high as possible
What should you be wary about for ROCE?
For low quality profit which boosts ROCE in the short-term.
Is leased equipment included in the calculations for ROCE?
No, as the calculations require capital employed, which is calculated using Non-current liabilities.
How would a business improve its ROCE?
- Improve profit lines, without increasing non-current liabilities (capital employed)
- maintain operating profit levels but reduce capital employed by paying back loans quickly.
What is gearing?
A measure of the proportion of assets invested in a business that are financed by long-term borrowing.
What does it mean if a business is highly geared?
If a business has a gearing greater than 50%.
This means that they have much of the business reliant upon long term loans.
What does it mean if a business is lowly geared?
If a business has a gearing lower than 50%.
This means that the business isn’t that reliant upon long-term loans
What gearing is ideal?
A business wants a low gearing as it helps the business become attractable to investors and stable financial.
What is the calculation for gearing?
(non-current liabilities) / (Capital Employed) x 100
What are the benefits of being highly geared?
- improve credit score and benefit from financial economies of scale
- gain advice and guidance from external sources of finance
- require less capital from shareholder
- keep control of your business (no-dilution due to share capital)
- debt + interest can be cheaper than dividends to pay.
Benefits of being lowly geared?
- less default on debt and the risk of borrowing decreased
- attractive for investors
- pay less interest and debts
- ability to take out loans as a contingency plan
- shareholders are a larger focus rather than debt providers
How would a business reduce its’ gearing?
- focus on profit quality
- repay long-term loans
- retain profits and no dividends
- issue more shares
- convert loans into equity
How would a business improve its’ gearing?
- focus on growth
- convert short term debts into long-term loans
- buy back shares
- pay more dividends
- issue preference shares or debentures
What are debentures?
A medium to long-term debt instrument used by large companies to borrow money at a fixed rate of interest
What are preference shares?
a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends
