3.7.2- Value of financial ratios

Question 1

What is ratio analysis

Answer 1

Involves the comparison of financial data to gain insights into business performance

Question 2

What is an income statement

Answer 2

A financial statement that repots a company’s financial performance over a specific accounting period

Question 3

What is a balance sheet

Answer 3

A statement of the assets, liabilities and capital of a business or other organisation at a particular point in time

Question 4

What is a statement of financial position

Answer 4

Alternative name for balance sheet

Question 5

What is a consolidad balance sheet

Answer 5

The total balance sheet for a business

Question 6

What is gross profit

Answer 6

Sales revenue - direct costs/ cost of sales/ variable costs

Question 7

What is operating profit

Answer 7

Gross profit - operating expenses/ fixed costs/ indirect costs

Question 8

What is profit for the year

Answer 8

Operating profit- taxation and other finance costs

Question 9

What are current assets

Answer 9

Within a year

Question 10

What are non-current assets

Answer 10

After a year

Question 11

What are examples of non-current assets

Answer 11

Land
Property
machinery
logo/ brand name

Question 12

What are examples of current assets

Answer 12

Stock
debtors
cash in bank

Question 13

What are liabilities

Answer 13

A company’s legal financial debts and or obligations

Question 14

What are examples of current liabilites

Answer 14

Overdraft
short term bank loan
creditiors

Question 15

What are examples of non-current liabilites

Answer 15

Mortgage
long-term loan
debenture repayment

Question 16

What is total equity

Answer 16

The total amount invested by the business/ shareholders

usually through retained profits

Question 17

Why does a balance sheet “blance”

Answer 17

Because every financial transaction results in an equal change in assets or liabilities- concept of “double entry”

Question 18

Where does the information for ratio analysis come from? - income statements

Answer 18

Revenues
cost of sales
gross profit
operation profit
profit for the year

Question 19

Where does the information for ratio analysis come from? - balance sheets

Answer 19

Current assets
current liabilities
inventories
trade receivables + payables
long term liabilities
capital + reserves

Question 20

What is working capital

Answer 20

Measures the amount of money available to a business to pay its day-to-day expenses

Working capital = current assets - current liabilities

Question 21

What is depreciation

Answer 21

The reduction of the value of an asset over a period of time

Question 22

What is a group income statement

Answer 22

Many companies get taken over and form a group of businesses

each company within a group retains a separate legal entity

group is legally obliged to produce a group income statement and balance sheet

Question 23

Income statements and the law

Answer 23

Legal requirement
companies must disclose exceptional items (large one off financial transactions regarding trading- eg set up cost of expanding into different country
and extraordinary items - ( large transactions outside normal trading)

Question 24

What are they key stages in ratio analysis

Answer 24

gather data
calculate ratios
interpret results
take action

Question 25

Limitations of ratio analysis

Answer 25

one data set is not enough
reliability of data?
based on the past
comparability

Question 26

Why might ratio data not be entirely reliable

Answer 26

Financial info involves making subjective judgements

different businesses have different accounting polices potential for manipulation of accounting info

Question 27

What is the importance of effective comparison

Answer 27

one ratio is rarely enough

need to compare with competitors

need to analyse over time (trends)

circumstances change over time

markets and industries change

different economic + market conditions

Question 28

What ratios dont tell you

Answer 28

competitive advantages
quality
ethical reputation
future prospects
changes in the external environment

Question 29

What is the formula for gross profit margin

Answer 29

gross profit/ revenue X 100

Question 30

What is the formula for operating profit margin

Answer 30

operating profit/ revenues X100

Question 31

What is return of capital employed
(ROCE)

Answer 31

A financial ratio that measures a company’s profitability and the efficiency with which its capital is employed.

Question 32

Calculation for Return of captial employed

Answer 32

operating profit/ (total equity + non-current liabilities) X100

Question 33

What is a current ratio

Answer 33

Liquidity is determined by the relationship between current assets and current liabilities.

Shows how well a business can deal with their short term obligations.

Current assets/ current liabilities

Question 34

What are payable days

Answer 34

The average length of time taken by a business to pay amounts it owes

Question 35

Calculation of payable days

Answer 35

payables/ cost of sales X 365

Question 36

What are receivable days

Answer 36

The average length of time taken by customers to pay amounts owed

= Receivables / sales rev X 365

Question 37

What is inventory turnover?

Answer 37

Measures how often each year a business sells and replaces its inventory

Cost of goods sold/cost of sales/ average inventories held

=……. times per year

Question 38

What is gearing

Answer 38

Measures the proportion of a business’ capital (finance) provided by debt

Non-current liabilities/ total equity + non current liabilities X 100