3.7.2 financial ratio analysis

Question 1

what are the two main financial reports?

Answer 1

income statement and balance sheets

Question 2

what is an income statement ?

Answer 2

shows the profit/loss that has been made over a certain time period

Question 3

what is profit quality?

Answer 3

the degree to which the profit is sustainable

Question 4

what is profit utilisation?

Answer 4

the way in which profit is used

Question 5

what is a balance sheet?

Answer 5

a document which shows assets, liabilities and capital of a business on a specific date

Question 6

what are current assets?

Answer 6

assets the business owns short term.
items used and replaces regularly, customers who owe money and money in the bank

Question 7

what are non-current assets?

Answer 7

last more than a year, cost a lot of money and could be sold to increase money owned by the business
e.g land, machinery, vehicles

Question 8

what are current liabilities?

Answer 8

amounts owed which are due to be paid within a year, money the business owes on credit and short term loans

Question 9

what are non-current liabilities?

Answer 9

money which is owed and will take more than a year to pay back

e.g loans, mortgages and debentures

Question 10

strengths of financial data:

Answer 10

1. valuable source of info
2. accounts have to be audited
3. income statement should reflect an accurate picture of what has happened

Question 11

weaknesses of financial data:

Answer 11

should be read along with the rest of the report about objectives/cash flow

balance sheet is only accurate at one point in time

Question 12

what is the purpose of ratio analysis?

Answer 12

to identify aspects of a business’s performance to aid decision making

Question 13

what are the 4 main areas of ratio analysis?

Answer 13

liquidity, profitability, financial and gearing

Question 14

what is current ratio and what is the formula?

Answer 14

it examines whether the business has enough short term assets to pay short term debts.
a business should aim for 1.5-2.5 : 1

current assets / current liabilities

Question 15

what is gross profit formula?

Answer 15

total revenue - variable costs

Question 16

what is operating profit formula?

Answer 16

total revenue - total costs

Question 17

what is the gross profit margin and what is the formula?

Answer 17

the higher the better, enables the firm to see how much it cost to generate the sales.
(gross profit / revenue) x100

Question 18

what is operating profit margin and what is the formula?

Answer 18

operating profit takes into account the fixed costs involved in production
(operating profit / revenue) x100

Question 19

what is return on capital employed and what is the formula?

Answer 19

measures how well management is using assets to generate profit
(operating profit / total equity + non current liabilities) x100

Question 20

what is gearing ratio and what is the formula?

Answer 20

measures the business exposure to interest rate fluctuations. over 50% is ‘highly geared’
(non-current liabilities / total equity + non-current liabilities) x100

Question 21

what is inventory turnover and what is the formula?

Answer 21

the rate at which a company’s inventory is turned over
cost of goods sold / average inventories held
(expressed as times per year)

Question 22

what is receivables days ratio and what is the formula?

Answer 22

a measure of how long it takes the business to recover debts
(receivables / revenue) x365

Question 23

what is payables days ratio and what is the formula?

Answer 23

a measure of how long is takes the business to pay its creditors
(payables / cost of goods sold) x365

Question 24

what is profitability?

Answer 24

measure of financial performance that compares profit to other factors such as revenue