7.2 Financial Ratio Analysis Flashcards
What is the formula for ROCE?
Operating profit/capital employed x100
What does ROCE show?
How efficiently finance is invested e.g. 30 mil producing 10 mil is more efficient than 100 mil producing 10 mil.
Formula for capital employed.
Total equity + non current liabilities.
What does total equity consist of?
Retained profits and share capital.
What is the ideal ROCE number?
Higher the better.
How can a business use financial ratios to assess performance?
Compare to previous years.
Compare to competition/industry average.
How do you calculate current ratio?
Current assets/current liabilities.
What is the ideal current ratio?
2
What does a good current ratio show?
Good liquidity - enough funds to cover current liabilities.
Good working capital management - financial management.
Formula for gearing ratio.
Non current liabilities/capital employed x100
What does gearing ratio show?
Capital structure.
How much of a firms capital employed is made up of debts.
What is the ideal gearing ratio?
25-50%
Why may a business have a high gearing ratio?
Low interest rates.
High and consistent profits.
To avoid using shares in order to maintain control.
How can a business improve gearing ratio?
Reduce non current liabilities - use cash to pay off debts.
Increase share capital.
Name 3 efficiency ratios.
Payables days.
Receivables days.
Inventory turnover.
What does payables days show?
How long it takes a business to pay back creditors e.g. suppliers.
Formula for payables days.
Payables/cost of sales x 365
Answer is in days.
Should payable or receive able days be larger?
Payables days.
What do higher payables days indicate?
Good liquidity.
Good cash flow.
What does receivables days measure?
How successfully managers are at chasing up payments from debtors.
Formula for receivables days.
Receivables/revenue x 365.
What could have negative impacts on a business’s receivables days?
Some may offer credit to increase sales - particularly for more luxury, expensive items.
How could a business improve increasing receivables days?
Debt factoring.
What does inventory turnover measure?
How quickly inventory is converted into sales.
Formula for inventory turnover.
Cost of sales/average inventories held
What does the inventory turnover number mean?
Number of times a business sells its stock in a year.
What is the ideal inventory turnover number?
Higher the better.
How can a business improve their inventory turnover?
Lean or just in time production.
Define capital employed.
Total amount of capital a firm uses to operate.
