5.5 Analysis of Accounts Flashcards
What is profitability?
The ability of a company to use its resources to generate revenues in excess of its expenses.
What do profitability ratios measure?
How profitable the business has been in the year ended.
What does Return on Capital Employed (ROCE) calculate?
The return in terms of the capital invested in the business.
What is the formula for ROCE?
Net Profit / Capital Employed x 100
What is Gross Profit Margin (GPM)?
The percentage of gross profit made on each unit of sales revenue.
What is the formula for Gross Profit Margin?
Gross Profit / Sales Revenue x 100
What does Net Profit Margin (NPM) represent?
The percentage of net profit generated on each unit of sales revenue.
What is the formula for Net Profit Margin?
Net Profit / Sales Revenue x 100
What does liquidity measure?
The ability of the company to pay back its short-term debts.
What is the formula for Current Ratio?
Current assets / Current liabilities
What does a higher Current Ratio indicate?
It is better; a value above 1 is favorable.
What is the Liquid Ratio/Acid Test Ratio?
A liquidity ratio that excludes inventory as a liquid asset.
What is the formula for Liquid Ratio?
(Current assets - Inventories) / Current Liabilities
Who uses accounts to control performance over products?
Managers
What can managers do with profitability ratios?
They can see which products are performing profitably and which are not.
How do shareholders use profitability ratios?
To see whether they should invest in the business by buying shares.
What do creditors assess from balance sheets and liquidity ratios?
The cash position and debts of the business.
What do banks look for in accounts before lending?
Profitability and liquidity of the firm.
What do government and tax officials examine in a business?
The profits to fix a tax rate and assess profitability and liquidity.
What do workers and trade unions want to know?
If the business’ future is secure or not.
What is a limitation of using ratio analysis?
Ratios are based on past accounting data and do not indicate future performance.
What issue arises from external users only having access to published accounts?
They may not get the ‘full-picture’ about the business’ performance.
How can inflation affect accounting data comparisons?
It can lead to misleading assumptions.
Why might different companies have unreliable ratio comparisons?
Different accounting methods may yield different ratio results.
