8 - Ratio Analysis Flashcards
What are the 2 liquidity ratios
Current ratio
Acid test ratio
How do you work out the current ratio
Current assets/current liabilities
How do you present answer for current ratio
Answer : 1
What is an ideal value for current ratio
2:1
Why is a >1:1 current ratio a concern
Indicates cash flow problems
Why is a <2:1 current ratio a concern
May be stock that can’t be sold
How to calculate acid test ratio
Current assets-stocks/current liabilities
What does an acid test ratio do that current ratio doesn’t
Takes into account that a firm may hold large amounts of stock
What are the activity/efficiency ratios
Asset turnover
Stock turnover
Debtor collection period
Creditor payment
What does efficiency/activity ratios show
How well a business manages its assets and liabilities l, including creditor and debtor days
How to work out asset turnover
Revenue/net assets
What is meant by net assets in asset turnover (efficiency ratio)
Non current assets
What does the answer for asset turnover tell you
The amount of revenue per £ of assets
How to work out stock turnover
Cost of sales/average stock held
What does the answer for stock turnover tell you
How many times stock is turned over each year
How do you work out how long it takes for stock to be turned over once
365/stock turnover
How to work out debtor collection period
Debtors/turnover x 365
What does the figure from debtors collection period tell you
How many days it takes debtors to pay you back on average
How to work out creditor payment
Creditors/cost of sales x 365
What does the figure from creditor payment tell you
How many days it takes you to pay back creditors on average
How to work out gearing ratio
Long-term liabilities/capital employed x 100
In gearing ratio, what will long term liabilities include
Loans and mortgages
What will capital employed include for gearing ratio
All investment that year eg loans, shares, retained profits
What does the gearing ratio mean
Works out the money that a firm owes back as a percentage of the liabilities’ total value
What can it mean if a business is ‘highly geared’
It is high risk
What does interest cover look at
The ability for interest payments to be covered by profits
How to calculate interest cover
Profit before tax and interest/interest
What is profit before tax and interest also known as
Operating profit
What does the answer from interest cover show
The number of times a firm can cover interest through profit
What are the profitability ratios
ROCE Gross profit margin Net profit margin Operating profit margin Return on equity
What does ROCE stand for
Return on capital employed
How to work out ROCE
Operating profit/capital employed x 100
What does ROCE tell us
The value of returns/profits on capital employed, as a percentage of capital employed
How to work out gross profit margin
Gross profit/sales revenue x 100
What does the gross profit margin show us
What profit the firm makes as a percentage of their sales (minus cost of sales)
How to work out net profit margin
Net profit/sales x 100
What does the net profit margin tell us
Profits as a percentage of sales (after all expenses)
How to work out operating profit margin
Operating profit/sales x 100
What does operating profit margin tell us
Profits as a percentage of sales (after expenses)
How to work out return on equity
Profit for year/value of shares (shareholder equity)
What does return on equity tell us
How much profit is made per £ of shares
What are the shareholder ratios
Earnings per share (EPS) Price earnings ratio Dividend per share Dividend yield Dividend cover
How to calculate EPS
Profit for year/number of shares issued
What does EPS show
How much profit each share has earned over past year
How to calculate price earnings ratio
Market price of share/EPS
What does price earnings ratio show
The market price of a share in comparison to what it will earn
What does it mean if price earnings ratio = 10
The market price is 10x the earnings of that share
How to calculate dividend per share
Total dividends paid/number of ordinary shares issued
What does dividend per share tell you
What dividends will be received for each share
How to calculate dividend yield
Dividend per share (p)/share price(p)
(p) = pence
What does dividend yield tell us
The dividend per share as a percentage of the share price
How to work our dividend cover
Profit after tax/dividends
What does dividend cover tell us
How many times dividends can be paid from net profits
What are the three types of investment appraisal
Payback
Net present value (NPV)
Average rate of return (ARR)
What does payback do
Works out how long it will take for an investment to generate enough revenue to cover its initial cost
What are the 3 columns in a payback table
Net cash inflow
Net cash outflow
Cumulative cash inflow
How to work out payback if it’s not exactly a year
Cumulative cash flow / net cash inflow
Advantages of payback
Simple to apply
Preview risk of investment
Tech is improving rapidly
Disadvantages of payback
Ignores cash flow after payback period
Only includes initial cost
What does net present value do
Forecast the value of an investment in future years
How to work out net present value in net present value table
Net return x discount factor
Why is discount factor included in net present value
Takes into account inflation
Advantages of NPV
Takes into account inflation
Compare different investment options
Disadvantages of NPV
Many assumptions
Difficult to calculate
What does ARR do
Measures the average profit gained as a percentage of the cost of an investment
Three steps to calculating ARR
1) Calculate total profit
2) Calculate average profit per year
3) average profit/total cost x 100
Advantages of ARR
Focuses on profit rather than payback
Easy to compare to other potential investments
Disadvantages of ARR
Uses average profits, even though it may be more profitable at different times
Ignores inflation
What is meant by a budget
Allocating a set amount of money for a project/investment
What is meant by variance
The difference between the budget and the actual spending on the project
What is a positive variance
When spending is lower than the budget
What is a negative variance
When spending is higher than the budget
What does a cash flow forecast show
Predictions of indies and outflows in a business
Advantages of cash flow forecast
Helps to set targets
Help to obtain finance
Spot problems in advance
Drawbacks of cash flow forecast
Estimations
External factors are not included
Where is working capital found
On a balance sheet
What is working capital
Money available for day to day transactions eg buying stock, paying wages
How is working capital calculated
Current assets - current liabilities
What is meant by the working capital cycle
The amount of time it takes to turn working capital into actual cash (eg sell stock)
How to work out WCC
Average working capital/sales revenue x 365
What does depreciation mean
The reduction in the value of an asset over time
What is straight line depreciation
Where an asset decreases in value by the same amount each year
Advantages of straight line depreciation
Easy to understand
Depreciates less at beginning, inflating value of business slightly
Disadvantages of straight line depreciation
Unsuitable for technology that goes out of date
Assumes lifespan
Inflated value of business in early years
What is percentage depreciation
Where the value of an asset falls by a set percentage each year
Advantages of percentage depreciation
Depreciates more at beginning (true)
Keeps some value in later years
Disadvantages of percentage depreciation
Assumes loss of value in early years
Reduces value of business (maybe harder to borrow money)
What is meant by net book value
Value of an asset after depreciation is accounted for
What is meant by residual value
An assets value at the end of its lifetime
