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Accounting and Finance ATAR > Analysis and Interpretation > Flashcards

Analysis and Interpretation Flashcards

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1
Q

Profitability Definition:

A

Refers to the earning capacity of the business during the accounting period.

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2
Q

What are the profitability ratios?

A
  • Profit
  • Gross Profit
  • Expense Ratio
  • Rate of return on assets
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3
Q

Profit ratio:

A

Shows the percentage of profit that is contained in each dollar of sales.

Profit/Net sales

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4
Q

What do the profit ratio results indicate?

A
  • The higher the better.
  • The ideal is any positive amount, as a negative amount indicates that a loss has been made.
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5
Q

Increasing Trend for profit ratio:

A
  • Selling a greater proportion of high-profit items
  • Cost of sales may have decreases
  • Expenses may have decreased
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6
Q

Decreasing Trend for profit ratio:

A
  • Selling a higher proportion of low-profit items.
  • Cost of sales may have increased
  • Expenses may have increased.
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7
Q

Gross profit ratio:

A

It is a measure of the level of profit available, after subtracting the cost of sales expense, to cover the remaining expenses of a business.
Gross Profit/Net sales

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8
Q

What do the Gross profit results tell us?

A
  • The higher the better
  • The ideal is any positive amount, as a negative amount indicates that a gross loss has been made
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9
Q

Increasing trend for gross profit ratio:

A
  • An increase in the inventory’s selling price is higher than any increase in the purchase price.
  • Business has purchased inventory at a lower price
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10
Q

Decreasing Trend for gross profit ratio:

A
  • An increase in the purchase price of inventory Is higher than any increase in selling price
  • A decrease in the selling price of inventory is possibly caused by a new competitor entering the market, a price war with competitors, or a desire to increase market share by selling inventory at a lower price.
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11
Q

Expense ratio:

A

Compares the sales to the total operating expenses. From this ratio, the owner of a business can see the extent to which the operating expenses have affected the profit.
Expenses ( Other than COGS)/Net Sales

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12
Q

What do the results of the expense ratio tell us?

A
  • The lower the better.
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13
Q

Increasing Trend in Expense Ratio:

A
  • Expenses have increased
  • Net sales have decreased
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14
Q

Decreasing Trend in Expense Ratio:

A
  • Expenses have decreased
  • Net sales have increased
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15
Q

Rate of return on Assets:

A

Ratio shows the overall earning power of total assets before any payments to equity or debt providers.
Profit/Average Assets

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16
Q

What do the results of the rate of return on assets tell us?

A
  • The higher the better
  • Ideal is a positive amount, as a negative result indicates that a loss has been made.
17
Q

Increasing Trend of Rate of return on asset:

A
  • Money invested is being used more efficiently.
  • Greater return earned from the same quantity of assets
18
Q

Decreasing Trend of rate of return on asset:

A
  • Businesses are using assets less efficiently
  • Businesses might need to consider reducing the amount invested in assets
19
Q

How to improve profitability?

A
  • Locating cheaper supplies
  • Increasing prices
  • Cutting operating costs
20
Q

Liquidity Definition:

A

Ratios assist in assessing the business’s ability to meet its financial commitments in the short term.

21
Q

What are the liquidity ratios?

A
  • Working capital/Current Ratio
  • Quick Asset/Acid test ratio
22
Q

Working capital/Current Ratio

A

Shows short-term debt-paying ability. It answers the question of whether the business can meet its debts as they fall due in the normal course of business.
Current Assets/Current Liabilities

23
Q

What do the results for the working capital/current ratio indicate?

A
  • The higher the ratio the better = Strong liquidity
  • Ideal level = 2:1, indicates that for every $1 of current liabilities, the business has $2 in current assets to meet that obligation
  • If ratio > 2:1 the business may be missing investment opportunities.
24
Q

Increasing trend for working capital/current ratio:

A
  • Inventory might be sold more slowly
  • Debtors may be taking longer to pay
  • Idle cash
25
Q

Decreasing trend for working capital/current ratio:

A
  • Inventory being sold more quickly
  • Debtors may be paying more promptly
26
Q

Quick Asset/Acid test Ratio:

A

Is a measure of the ability of a business to pay its short-term debts using only its more liquid current assets.
Current Assets (Excluding inventory and prepayments)/Current Liabilities (Excluding bank overdraft)

27
Q

What do the results for the Quick asset/Acid test ratio tell us?

A
  • Higher the better = Strong liquidity
  • The ideal level is 1:1 or more, which means the business can pay its immediate debts
  • If the ratio is less than 1:1 then it means that a business cant pay off immediate debts.
28
Q

Increasing Trend Quick Asset/Acid Test Ratio:

A
  • Debtors short-term investments or cash might have increased
  • Creditors have decreased.
29
Q

Decreasing Trend Quick Asset/Acid Test Ratio:

A
  • Debtors, short-term investments, or cash might have decreased
  • Creditors might have increased.
30
Q

How to improve Liquidity:

A
  • Additional Capital
  • Using Credit Terms for debtors
  • Increasing collections from debtors
  • Using Cheaper supplies.
31
Q

Gearing/Leverage Definition:

A

Describes the extent to which a business has funded its operations from borrowed funds rather than equity.

32
Q

Gearing/Leverage Ratios:

A
  • Debt to Equity Ratio
33
Q

Debt to equity Ratio:

A

Measures how the business has funded its assets comparing the total liabilities to the amount of contributed equity.
Total Liabilities/Equity(End)

34
Q

What do the results for debt to equity tell us?

A
  • The lower it is, the safer - financially
  • The ideal result is a ratio below 1:1 as this indicates that the business is less reliant on external financing pressures.
35
Q

Increasing trend for debt to equity ratio:

A
  • Higher level of borrowed funds
  • Liabilities increased
  • Interest rate pressures might cause problems for the business.
36
Q

Decreasing Trend for debt to equity ratio:

A
  • Lower level of borrowed funds
  • Equity Increased
  • Interest rates are less of concern
37
Q

How to improve leverage?

A
  • Paying off Debt
  • Contributing additional capital
  • Cutbacks on inventory purchases
  • Delaying a major capital investment
38
Q

Business analysis report format:

A

D - Define the type of ratio
R - Results (Compare business results)
U - Use ratio analysis (What do results tell us)
M - Make a recommendation/judgment (Which business is better in this area?)

Accounting and Finance ATAR (8 decks)

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