assessing competitiveness

Question 1

The benefits of calculating financial ratios for a business

Answer 1

gives a more powerful analysis of a businesses health and performance than looking at financial accounting statements that can only tell a business so much

Question 2

types of ratio

Answer 2

• profitability: relationship between gross/operating/net profit and revenue, assets and capital
• liquidity (health): ability of a firm to meet short-term debts with cash or near cash assets
• gearing (health): shows the proportion of the long-term finance in a business that has come from loans

Question 3

two types of liquidity ratios

Answer 3

current ratio and acid test ratio

Question 4

current ratio formula

Answer 4

current assets/ current liabilities

Question 5

ideal value for the current ratio

Answer 5

1.5. If the ratio is too high, its wasted money that could be invested elsewhere in the business. If it falls too low, it indicates the firm is suffering liquidity crisis, and can’t pay off debts when due

Question 6

Acid test ratio formula

Answer 6

discounts inventory as something that can quickly be turned to cash: current assets - inventory / current liabilities

Question 7

ideal value for acid test ratio

Answer 7

ideal is 1. acid test being way below 1 can indicate financial problems

Question 8

gearing ratio formula

Answer 8

expresses long-term liabilities as a percentage of total amount of long-term capital: long-tern liabilities / capital employed x 100

Question 9

what do high gearing ratios tell us?

Answer 9

(high is considered above 50%) it represents cash drain: high levels of debt

Question 10

how do you reduce high levels of gearing

Answer 10

issue more shares, retain more profits, repay some loans

Question 11

capital employed

Answer 11

adds shareholders capital (total equity) to loan capital (long - term liabilities) to work out the total long-term finance in the business

Question 12

how can a businesses profitability be assesed

Answer 12

by calculating profit margins as these show profit as a percentage of revenue. There are three main profit margins
gross
operating
net

Question 13

profit margin formulas + what they show

Answer 13

x profit / revenue x 100

x profit per £ of sales

Question 14

how to improve gross profit margin

Answer 14

price up

unit vc down

Question 15

how to improve operating profit margin

Answer 15

boost gross margin
cut overheads per £ of sales
increase sales

Question 16

how to improve net profit margin

Answer 16

boost operating profit margins

cut corporation tax bill

Question 17

problem if gross profit margin too low

Answer 17

may not be enough gross profit to cover overhead expenses

Question 18

problem if operating profit margin too low

Answer 18

may not be enough operating profit to re-invest into the business and grow

Question 19

problem if net profit margin too low

Answer 19

too low to provide shareholders with acceptable annual dividends

Question 20

what does ROCE stand for + what it shows

Answer 20

Return on capital employed - shows a return on that capital that is comparable with other potential uses of capital.

Question 21

ROCE formula

Answer 21

expresses op profit as a percentage of capital that has been invested into the business: operating profit / capital employed x 100

Question 22

is it better for ROCE figure to be high or low

Answer 22

higher, a higher return means the money invested in the business is generating a higher return on that investment

Question 23

How do you boost ROCE

Answer 23

find a way to increase op profit

reduce capital employed without damaging op profit

Question 24

what can Gearing and Liquidity ratios tell a business when making decisions

Answer 24

whether a business can afford to invest money in new projects

Question 25

what can ROCE tell a business

Answer 25

can help asses attractiveness of a new investment, or identify underperforming parts of a business

Question 26

Limitations of Ratio analysis

Answer 26

it doesn’t tell us the whole story, doesn’t take into account the changes to a firms external environment (e.g fashions making stock worthless for current ratio)