3.6 Flashcards
Stock turnover ratio
Measures how quickly a firm’s stock is sold and replaced over a given period, either in times or days
Efficiency ratios
Assesses how well a firm internally utilises assets and liabilities, they also help analyse the performance of a firm
Debtor days ratio
Measures the average number of days a firm takes to collect its debts
Creditor days ratio
Measures the average number of days affirm takes to pay its creditors
Gearing ratio
Measures the extent to which the capital employed by a firm is financed from loan capital
The importance of stock turnover ratio
Assesses the effectiveness of working capital management which is an assessment of the way current assets and current liabilities are being managed.generally the faster business turns over its stock the better.however this must still be done profitably rather than selling stock at low gross profit margins or at a loss
Strategies to improve stock turnover ratio
- dispose of slow moving are obsolete goods which will reduce the firms level of stock.downside is losses due to loss sales revenue that goods could’ve generated
- Offer narrower better selling range of products.the disadvantage is that it minimise variety of products to consumers
- Keep low levels of stock so that the cost of holding stock are reduced.sudden increases in may not be sufficient to sustain the market by the low level of stock
- Adopted just(JIT) production method, where stocks of materials are ordered only when they are needed. major drawback is delays in delivery which could affect production and sales
Importance of debtor days
Shorter debtor days give the business working capital to run day today operations. long credit period could lead to cash flow problems and liquidity crisis
Strategies to improve debtor days ratio
- provide discounts or incentives to encourage debtors to pay their debts earlier. drawback is less income from these customers and originally agreed
- impose stiff penalties including fines for late payers but this may result in a loss of loyal customers
- Stop further transactions with overdue debtors until payment is finalised
- Court action for consistently late players which may harm the reputation of the business with customers
Strategies to improve creditor days ratio
- Have good relationships with creditors which could enable the firm to negotiate for an extended credit period
- Effective credit control, managers needs to assess risks of paying creditors early versus late
Gearing ratio ranges
If a firm is highly geared, it could be viewed as risky by financials who would be reluctant to lend to businesses.shareholders and potential investors will be concerned since they may not foresee any future dividend payments due to the main obligation of the firm being to pay their long-term loans. Sudden interest rate changes were worse in loan or payment position of the business
However a low geared business could be viewed a safe but they could still not be borrowing enough to fund future growth which will make shareholders think that they will offer minimal returns.they may even prefer high gear businesses with good growth strategies
Strategies to improve gearing ratio
- Seek alternative source of funding that are not loan related for example issuing more shares.the drawback is that it takes a long time to issue shares and it may go against the objective of existing shareholders who don’t wanna lose ownership of the business
- Decide not to issue dividends to increase retained profit. but this may lead to resentment among shareholders especially if the reasons aren’t explained well
Insolvency
A financial state where a firm cannot meet their debt payments on time
The firm no longer has the money to pay off debt obligations and their debts exceeded their assets. a solution is to declare bankruptcy
Bankruptcy
A legal process that happens when a firm declares that they can no longer pay their debts to creditors
It is a legal process to liquidate the property and assets that the debtor owns to pay off their debts.this can sometimes provide protection and relief for the firm that is unable to pay off their debts.the firm will have to comply with bankruptcy duties and once all necessary tasks are completed the firm can be released from bankruptcy and become solvent again which takes between 9 to 21 months .
Difference between insolvency and bankruptcy
And solvent is a financial state whereas bankruptcy is a legal declaration and process. Insolvency is a state of economic distress that an organisation may be able to work through while bankruptcy leads to court dictating how the debts will be covered
