Accounting Ratios

Question 1

Return on Shareholder’s Funds (ROSF)

Answer 1

Profit for Year (less dividends) / Ordinary Share Capital + Reserves %

Question 2

What does ROSF show?

Answer 2

It is a measure of how well the business has used shareholder’s funds to generate profits for the company.

Question 3

Return on Capital Employed (ROCE)

Answer 3

Operating Profit / Share Capital +Reserves + N-C Liabilities %

Question 4

What does ROCE show?

Answer 4

It is a measure of how well the business has used the capital invested in the business to generate profits.

Question 5

Operating Profit Margin

Answer 5

Operating Profit / Sales Revenue %

Question 6

What does operating profit margin show?

Answer 6

It shows how well the business has converted sales revenue into operating profit.

Question 7

Gross Profit Margin

Answer 7

Gross Profit / Sales Revenue %

Question 8

List the ratios used to measure profitability.

Answer 8

• ROSF
• ROCE
• Operating Profit Margin
• Gross Profit Margin

Question 9

List the ratios used to measure efficiency.

Answer 9

• Sales revenue to capital employed
• Sales revenue per employee
• Inventories turnover period
• Settlement period for trade receivables
• Settlement period for trade payables

Question 10

Sales Revenue to Capital Employed

Answer 10

Sales Revenue / Share Capital + Reserves + N-C Liabilities

Question 11

What does Sales Revenue to Capital Employed show?

Answer 11

It is a measure of how well the business has used capital invested in the business to generate sales revenue.

Question 12

What is ROCE a combination of?

Answer 12

ROCE is a key measure of financial performance as it is a combination of profitability and efficiency.

Operating Profit Margin x Sales Revenue to Capital Employed

Question 13

Sales Revenue per Employee

Answer 13

Sales Revenue / Number of Employees

Question 14

What does Sales Revenue per Employee show?

Answer 14

It is a measure of how productive the workforce has been.

Question 15

What is working capital?

Answer 15

Working Capital = Current Assets - Current Liabilities

The key components are inventory, receivables and payables.

Companies often fail due to running out of cash, this is normally due to poor working capital control.

Question 16

Inventories Turnover Period

Answer 16

(Average (or year end) Inventories / Cost of Sales) x 365 days

Question 17

Settlement Period for Trade Receivables

Answer 17

(Average (or year end) trade receivables / Credit Sales Revenue) x 365 days

Question 18

Settlement Period for Trade Payables

Answer 18

(Average (or year end) trade payables / Credit Purchases Revenue) x 365 days

When purchases are not available then Cost of Sales is used.

Question 19

List the liquidity ratios.

Answer 19

• Current Ratio

- Quick Ratio

Question 20

Current Ratio

Answer 20

Current Assets / Current Liabilities

Question 21

What does the Current Ratio show?

Answer 21

It is a measure of how well the business is able to settle its short-term obligations as they fall due for payment.

Question 22

Quick Ratio

Answer 22

Current Assets - Prepayments - Inventory / Current Liabilities

Question 23

What does the Quick Ratio show?

Answer 23

It is a measure of how well the business is able to settle its short term obligations ‘in and emergency’.

Question 24

What is over-trading?

Answer 24

It is when a business is operating at a level of activity that cannot be supported by the available finance.

This usually occurs in a young/growing business, or a business with a lack of financial investment.

Question 25

Where is over-trading usually reflected in?

Answer 25

- A lower than expected current ratio - A lower than expected inventories turnover period - A lower than expected settlement period for trade receivables - A higher than expected settlement period for trade payables

Question 26

List the financial gearing ratios.

Answer 26

- Gearing Ratio | - Interest Cover

Question 27

Gearing Ratio

Answer 27

N-C Liabilities / Share Capital + Reserves + N-C Liabilities %

Question 28

What does the Gearing Ratio show?

Answer 28

It is a measure of the proportion of debt (interest-bearing and fixed return obligations) in the capital structure of the business.

Question 29

Interest Cover

Answer 29

Operating Profit / Interest Payable

Question 30

What does Interest Cover show?

Answer 30

It is a measure of the relative ease at which the interest charge has been covered by profits available.

Question 31

List the investment ratios.

Answer 31

- Dividend Payout Ratio - Dividend Yield - Earnings per Share - Price/Earnings Ratio These enable investors to measure the returns on their investment.

Question 32

Dividend Payout Ratio

Answer 32

Dividends Announced / Earnings for the Year Available for Dividends %

Question 33

What does the Dividend Payout Ratio show?

Answer 33

It shows the proportion of earnings that are paid out to shareholders.

Question 34

Dividend Yield

Answer 34

(Dividend per Share/(1-t)) / Market Value per Share %

Question 35

What does the Dividend Yield show?

Answer 35

It is a measure of the cash return from dividends relative to the current share price.

Question 36

Earnings per Share

Answer 36

Earnings for the year available to ordinary shareholders / Number of ordinary shares in issue

Question 37

What does Earnings per Share show?

Answer 37

It is a measure of the amount of profits earned for shareholders relative to the number of shares held.

Question 38

Price/Earnings Ratio

Answer 38

Market Value per Share / Earnings per Share

Question 39

What does the Price/Earnings Ratio show?

Answer 39

It is a measure of the amount of stock market confidence in the future earning power of a company.

Question 40

List the limitations of Ratio Analysis.

Answer 40

- Subjectivity in accounting estimates - Flexibility in accounting rules / policies - Accounting information is historical - Ratios ignore inflation - The SoFP is only a snapshot and may not be representative - No target values for ratios so comparable data is needed - Ignores other non-financial factors