7 - Financial Ratio Analysis Flashcards by Lucas Maniglia Brigagao Perry

Describe The Balance Sheet
(3 Points)

~ Record of what the company owes, is owed and owns in a specific point in time.

~ Used by PLCs and LTDs.

~ Shows assets, liabilities, equity, share capital and working capital.

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What Is Meant By ‘Working Capital’?

Difference between current assets and current liabilities.

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What Is Meant By ‘Non-Current Assets’, On The Balance Sheet?

Assets the business is likely to keep for more than a year.

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What Is Meant By ‘Current Assets’, On The Balance Sheet?
(2 Points)

~ Likely to be turned into cash within a year.

~ E.g. Receivables and inventory.

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What Is Meant By ‘Non-Current Liabilities’, On The Balance Sheet?
(2 Points)

~ Debts the business will pay off over several years.

~ E.g. Loans.

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What Is Meant By ‘Current Liabilities’, On The Balance Sheet?
(2 Points)

~ Debts the business needs to pay off within a year.

~ E.g. Payables and overdrafts.

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Describe Income Statements
(3 Points)

~ Profit and loss account.

~ Record of the revenues and costs, over a period of time.

~ Used by PLCs, LTDs and sole traders.

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On An Income Statement, How Is ‘Gross Profit’ Calculated?

Sales Revenue - Cost Of Sales.

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On An Income Statement, How Is ‘Operating Profit’ Calculated?

Gross Profit - Expenses.

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On An Income Statement, How Is ‘Profit For The Year’ Calculated?

Operating Profit - Interest.

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What Is Ratio Analysis Used For, Within A Business?
(2 Points)

~ More meaningful analysis of published accounts.

~ Allows for internal and external comparisons to be made.

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What Are All The Financial Ratios?
(4 Points)

~ ROCE.

~ Current ratio.

~ Gearing.

~ Efficiency ratios.

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What Are All The Efficiency Ratios?
(3 Points)

~ Payable days.

~ Receivable days.

~ Inventory turnover.

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Describe ROCE
(3 Points)

~ Profitability ratio.

~ Measures how efficiently a business is managing its finance.

~ The higher the better, but needs to be compared to previous years, rivals and bank interest rates.

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What Is The Formula For ROCE?
(4 Points)

~ Operating Profit / Capital Employed x 100.

~ Capital Employed = Total Equity + Non-Current Liabilities.

~ Total Equity = Retained Profits + Share Capital.

~ Non-Current Liabilities = Long term debts.

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In The ROCE Formula, Where Does Each Measure Come From?
(2 Points)

~ Operating Profit = Income statement.

~ Total Equity + Non-Current Liabilities = Balance sheet.

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How Can ROCE Be Improved?
(2 Points)

~ Increase operating profit, by increase revenue or being more cost efficient.

~ Decrease capital employed, by paying off long term debts.

Describe The Current Ratio
(2 Points)

~ Liquidity ratio.

~ Measures how much money is available to a business, to pay off things.

What Is The Formula For Current Ratio?
(3 Points)

~ Current Assets / Current Liabilities.

~ Current Assets = Debtors, cash and stock.

~ Current Liabilities = Creditors and overdrafts.

In The Current Ratio, Where Does Each Measure Come From?

Balance sheet.

What Are The Values For Current Ratio, That Are Deemed Ideal Or A Problem?
(2 Points)

~ 1.5 -> 2 = Ideal, suggesting good liquidity and good working capital.

~ Below 1.5 = Problem, might struggle to meet its current liabilities.

How Can Current Ratio (Liquidity) Be Improved?
(3 Points)

~ Decreasing stock levels.

~ Speed up collection of debts owed to your business.

~ Slow down payments to suppliers.

Describe Gearing
(3 Points)

~ Capital structure ratio.

~ Shows investors how much of a business ‘capital employed’ is made up of non-current liabilities.

~ Shows investors, whether they should invest in the business.

What Is The Formula For Gearing?
(4 Points)

~ Non-Current Liabilities / Capital Employed x 100.

~ Capital Employed = Total Equity + Non-Current Liabilities.

~ Total Equity = Retained Profits + Share Capital.

~ Non-Current Liabilities = Long term debts.

In The Gearing Ratio, Where Does Each Measure Come From?

Balance sheet.

Describe A Highly-Geared Business (3 Points)

~ 50% +, half the businesses finance comes from non-current liabilities. ~ More vulnerable to interest rate changes, if they increase, costs may go up, due to the cost of servicing the debt. ~ Business may be more willing to take risks.

Describe A Low-Geared Business (3 Points)

~ Less than 25%, mosts funds come from shareholders. ~ 25 -> 50%, is an acceptable range. ~ Business may be more risk adverse.

How Can Businesses Reduce Their Gearing Ratio? (2 Points)

~ Reduce non-current liabilities. ~ Increase share capital.

What Do Efficiency Ratios Show?

Shows managers and shareholders, how well the business is using its resources.

Describe Payable Days (3 Points)

~ Measure of how long it takes to pay back creditors (Suppliers). ~ Low number suggests, good liquidity and cash flow. ~ Short days, means possible discount from suppliers.

What Is The Formula For Payable Days? (3 Points)

~ Payables / Cost Of Sales x 365. ~ Payables = Current liability. ~ Cost Of Sales = Costs of producing the good.

In The Payables Formula, Where Does Each Measure Come From? (2 Points)

~ Payables = Balance sheet. ~ Cost Of Sales = Income statement.

Describe Receivable Days (2 Points)

~ Measures how long it takes debtors (Customers) to pay back the business. ~ Low number suggests, good liquidity and cashflow.

What Is The Formula For Receivable Days? (3 Points)

~ Receivables / Revenue x 365. ~ Receivables = Current asset. ~ Revenue = Turnover.

In The Receivables Formula, Where Does Each Measure Come From? (2 Points)

~ Receivables = Balance sheet. ~ Revenue = Income statement.

Describe Inventory Turnover (3 Points)

~ Measures how quickly inventory is converted into sales. ~ Higher the better, less cash tied up in inventory. ~ Number is reducing, is bad as suggests problem with stock.

What Is The Formula For Inventory Turnover? (2 Points)

~ Cost Of Sales / Average Inventory Held. ~ Tells us the number of times in one year, that a business sells its inventory.

In The Inventory Turnover Formula, Where Does Each Measure Come From? (2 Points)

~ Cost Of Sales = Income statement. ~ Average Inventory Held = Balance sheet.

How Can Inventory Turnover Be Improved? (2 Points)

~ Using JIT. ~ Increasing sales.

What Is The Value Of Ratio Analysis? (4 Points)

~ Identify strengths and weaknesses. ~ Helps inform decision making. ~ Helps inform investor decision making. ~ Comparisons with other businesses, to see performance.

What Is The Limitation Of Ratio Analysis? (2 Points)

~ Doesn't take into account internal strengths. ~ Doesn't take into account external factors, such as future market changes.