assessing competitiveness Flashcards
The benefits of calculating financial ratios for a business
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
types of ratio
- 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
two types of liquidity ratios
current ratio and acid test ratio
current ratio formula
current assets/ current liabilities
ideal value for the current ratio
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
Acid test ratio formula
discounts inventory as something that can quickly be turned to cash: current assets - inventory / current liabilities
ideal value for acid test ratio
ideal is 1. acid test being way below 1 can indicate financial problems
gearing ratio formula
expresses long-term liabilities as a percentage of total amount of long-term capital: long-tern liabilities / capital employed x 100
what do high gearing ratios tell us?
(high is considered above 50%) it represents cash drain: high levels of debt
how do you reduce high levels of gearing
issue more shares, retain more profits, repay some loans
capital employed
adds shareholders capital (total equity) to loan capital (long - term liabilities) to work out the total long-term finance in the business
how can a businesses profitability be assesed
by calculating profit margins as these show profit as a percentage of revenue. There are three main profit margins
gross
operating
net
profit margin formulas + what they show
x profit / revenue x 100
x profit per £ of sales
how to improve gross profit margin
price up
unit vc down
how to improve operating profit margin
boost gross margin
cut overheads per £ of sales
increase sales
how to improve net profit margin
boost operating profit margins
cut corporation tax bill
problem if gross profit margin too low
may not be enough gross profit to cover overhead expenses
problem if operating profit margin too low
may not be enough operating profit to re-invest into the business and grow
problem if net profit margin too low
too low to provide shareholders with acceptable annual dividends
what does ROCE stand for + what it shows
Return on capital employed - shows a return on that capital that is comparable with other potential uses of capital.
ROCE formula
expresses op profit as a percentage of capital that has been invested into the business: operating profit / capital employed x 100
is it better for ROCE figure to be high or low
higher, a higher return means the money invested in the business is generating a higher return on that investment
How do you boost ROCE
find a way to increase op profit
reduce capital employed without damaging op profit
what can Gearing and Liquidity ratios tell a business when making decisions
whether a business can afford to invest money in new projects
what can ROCE tell a business
can help asses attractiveness of a new investment, or identify underperforming parts of a business
Limitations of Ratio analysis
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)
