3.6 - Debt/Equity Ratio Analysis - Efficiency Ratios Flashcards
what are debtors
organisations or individuals who owe a business money
-> business wants debtors to pay them back as early as possible
(cash in)
what are creditors
organisations or individuals which businesses owe money to
-> they want to pay it back as late as possible
(cash out)
why is it important to have debtors pay as early as possible and creditors pay as late as possible
good for cash flow
what is debtor days
the average time (number of days) it takes to collect money from debtors
what is creditor days
average time (in days) that it takes to pay suppliers
where can you find the information to calculate creditor/debtor days
debtors + trade creditors = balance sheet
sales revenue + cost of sales = P+L
how can a business improve debtor/creditor days
decrease debtor days
* reduce trade credit
increase creditor days
* increase trade credit - find a supplier who will allow it to be longer
* delay payments to suppliers
what is stock turnover (number of times)?
how many times a stock is bought in per year
what is the calculation for stock turnover (number of times)?
(cost of sales) / (average stock)
what is stock turnover (number of days)?
the amount of time (number of days) it takes for stock to be sold
what is the equation for stock turnover (number of days)
(average stock/cost of sales) x 360
what is a gearing ratio
how reliant the business is on long-term liabilities (eg. loans from a bank)
what are the different types of efficiency ratios?
- stock turnover (days)
- stock turnover (times)
- gearing ratio
- creditor days
- debtor days
what is the calculation for gearing ratio?
how do you interperate the score of a gearing ratio?
(non-current liabilities/non-current liabilities + equity) x 100
the higher the gearing ratio:
* the higher the reliance on long term liabilities
* higher interest payments
* high debt levels
* higher risk
what do the different outcome values of a gearing ratio tell us?
- higher than 50% - too much reliance on long term liabilities -can lead to problems in long term - financial risk
- lower than 25% - considered low risk by investors and lenders
- between 25% and 50% - optimal or normal
how can a gearing ratio be improved
- sell assets and repay loans
- sell shares and repay loanes
- pay less dividends
what is insolvency
the state where a business is unable to pay back loans and liabilities - no longer able to pay debts when they are due
(financial state)
what is bankruptcy
when a court of law passes that a business is unable to pay their debts
- assets will usually be liquidated to pay off debts
when it is legally announced that a business can not pay off its debts
(legal state)
what is liquidation
the process by which assets are sold to settle liabilities
what is administration
the process where a company attempts to protect themselves as they try to pay back loans and liabilities - to escape insolvency
