3.5.2 Ratio analysis

Question 1

How do you work out R.O.CE?

Answer 1

(Operating Profit) / (Capital Employed) x100

Question 2

How do you work out capital employed?

Answer 2

(Non-current Liabilities + total equity)

Question 3

How do you work out total equity?

Answer 3

share capital + retained profit

Question 4

What is R.O.C.E?

Answer 4

Return on Capital Employed

Question 5

What does R.O.C.E allow you to measure?

Answer 5

It helps you evaluate the overall performance of the business.

Question 6

What can you do with R.O.C.E?

Answer 6

• Set targets

- compare performance with the competition

Question 7

What does Return on capital employed mean?

Answer 7

Also known as the primary ratio, It tells us what returns (profits) the business has made on the resources available to it.

Question 8

What is capital employed?

Answer 8

a measure of the total resources that a business has available.

Question 9

What is the ideal value of ROCE?

Answer 9

As high as possible

Question 10

What should you be wary about for ROCE?

Answer 10

For low quality profit which boosts ROCE in the short-term.

Question 11

Is leased equipment included in the calculations for ROCE?

Answer 11

No, as the calculations require capital employed, which is calculated using Non-current liabilities.

Question 12

How would a business improve its ROCE?

Answer 12

• Improve profit lines, without increasing non-current liabilities (capital employed)
• maintain operating profit levels but reduce capital employed by paying back loans quickly.

Question 13

What is gearing?

Answer 13

A measure of the proportion of assets invested in a business that are financed by long-term borrowing.

Question 14

What does it mean if a business is highly geared?

Answer 14

If a business has a gearing greater than 50%.

This means that they have much of the business reliant upon long term loans.

Question 15

What does it mean if a business is lowly geared?

Answer 15

If a business has a gearing lower than 50%.

This means that the business isn’t that reliant upon long-term loans

Question 16

What gearing is ideal?

Answer 16

A business wants a low gearing as it helps the business become attractable to investors and stable financial.

Question 17

What is the calculation for gearing?

Answer 17

(non-current liabilities) / (Capital Employed) x 100

Question 18

What are the benefits of being highly geared?

Answer 18

• 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.

Question 19

Benefits of being lowly geared?

Answer 19

• 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

Question 20

How would a business reduce its’ gearing?

Answer 20

• focus on profit quality
• repay long-term loans
• retain profits and no dividends
• issue more shares
• convert loans into equity

Question 21

How would a business improve its’ gearing?

Answer 21

• focus on growth
• convert short term debts into long-term loans
• buy back shares
• pay more dividends
• issue preference shares or debentures

Question 22

What are debentures?

Answer 22

A medium to long-term debt instrument used by large companies to borrow money at a fixed rate of interest

Question 23

What are preference shares?

Answer 23

a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends