4. Analyzing and Interpreting Financial Statements Flashcards
What are the 5 financial ratio types studied?
- Profitability
- Efficiency
- Liquidity
- Financial gearing
- Investment
What are “profitability” ratios?
Profitability ratios are financial metrics used by analysts and investors to measure and evaluate the ability of a company to generate income (profit) relative to revenue, operating costs, balance sheet assets, and shareholder’s equity during a specific period of time. They show how well a company utilizes its assets to produce profit and value to shareholders.
A higher ratio or value is commonly sought-after by most companies, as this usually means the business is performing well by generating revenues, and profits. The ratios are most useful when they are analysed in comparison to similar companies or compared to previous periods.
What 2 groups are “profitability” ratios divided into?
- Margin ratios (Gross, Operating, Net profit)
- Return (Return on Capital Employed, Return on Equity, Return on Total Assets)
What are the 3 profitability ratios?
Gross Profit Margin (GPM)
Operating Profit Margin
Return on Capital Employed
What is the equation for “Gross Profit Margin”?
= (Gross Profit / Sales Revenue) x 100
What is the equation for “Operating Profit Margin”?
= (Operating Profit / Sales Revenue) x 100
What is the equation for “Return on Capital Employed”?
= (Operating Profit / Share Capital + Reserves + Non-Current Liabilities) x 100
What does the “Return on Capital Employed” (ROCE) equation tell us?
ROCE is a financial ratio that is used to measure the profitability of a company and the efficiency with which it uses its capital. Put simply, it measures how good a business is at generating profits from capital.
= (Operating Profit / Share Capital + Reserves + Non-Current Liabilities) x 100
What are “Efficiency” ratios?
Efficiency ratios are metrics that are used in analysing a company’s ability to effectively employ its resources, such as capital and assets, to produce income.
The more efficiently a company is managed and operates, the more likely it is to generate maximum profitability for its owners and shareholders over the long term.
Analysts and investors consider efficiency ratios to be an important measure of the current and short-term performance of an organization
What are the 4 “Efficiency” ratios?
- Average inventories turnover period
- Average settlement period for trade receivables
- Average settlement period for trade payables
- Sales revenue to capital employed ratio
What is the equation for “Average inventories turnover period”?
(Average inventories held / Cost of sales ) x 365
What is the equation for “Average settlement period for trade receivables”?
(Average trade receivables / Credit sales revenue) x 365
What is the equation for “Average settlement period for trade payables”?
(Average trade payables / Credit purchases) x 365
What is the equation for “Sales revenue to capital employed ratio”?
(Sales revenue / Share capital + Reserves + Non-current liabilities)
What are “Liquidity” ratios?
A liquidity ratio is a type of financial ratio used to determine a company’s ability to pay its short-term debt obligations. The metric helps determine if a company can use its current, or liquid, assets to cover its current liabilities.
