BUSS3 - Financial Ratios Flashcards
Current Ratio
Compares current assets INCLUDING STOCK to current liabilities
Current ratio should be higher than 1:1
1.5:1 or 2:1 is considered ideal
Value much below 1.5:1 suggests a liquidity problem and that it might struggle to meet its current liabilities
Acid test ratio
Compares current assets EXCLUDING STOCK to current liabilities
Shows how much of what a business owes in the short term is covered by its current assets
Doesn’t include stock because it isn’t always easy to sell stock in time to pay off debts
Ratio of 1:1 is ideal (shows both amounts are the same)
Asset Turnover Ratio
Compares sales revenue a
business makes to the value
of its total assets
Shows how much sales revenue a business is making from every
pound’s worth of its assets
Low asset turnover ratio could
suggest that the business isn’t using its non-current assets efficiently
Low asset turnover ratio could
also mean that the firm has too
many current assets
A good asset turnover ratio depends on the type of business
Managers should compare the asset turnover ratio to previous operative periods to see if the firm is improving its efficiency over time
Ratio can be improved by getting rid of under-used non-current assets or holding less stock
Operating machinery to full capacity helps fixed assets generate the maximum amount of revenue. Problem is that machinery operating at its limit
is more likely to break down and need expensive repairs or replacement
Inventory/Stock turnover ratio
Compares the cost of all the sales a business makes over a year to the average value of stock that it holds
Tells you how many times a year the business sells all its stock
Can be improved by holding less
stock or increasing sales
Receivables days ratio
Compares the average amount owed to a business by its debtors to the value of total
sales that it gives buyers credit for
Number of days that the business has to wait to be paid for goods it supplies on credit
Best to have low receivables days because it helps with cash flow and working capital
Payables days ratio
Compares the average amount the business owes to its creditors to the value of the total
purchases that it makes on credit
Number of days the firm takes
to pay for goods it buys on
credit from suppliers
Gross Profit Margin
Measures the relationship
between the gross profit and
the value of sales
Expressed as a percentage
What counts as good gross
profit margin depends on the
type of business
Ratio can be improved by
increasing prices or reducing
the direct cost of sales
A business can improve its overall gross profit margin by stopping selling products with a low gross profit margin
Net Profit Margin
Takes overheads (indirect costs) into account
Expressed as a percentage
Best to have a high net profit
margin although it depends on
type of business
A business with a declining net profit margin compared to gross profit margin is having trouble with its overheads
Can be improved by raising
revenue of lowering cost of sales or overheads
ROCE
Expressed as a percentage
Can be improved by paying off debt to reduce non-current liabilities or by making the business more efficient to increase operating profit
Decent ROCE is about 20-30%
Tells you how much money is made by the business compared to how much money’s been put into the business
Best way of analysing profitability
Dividend yield
Shareholders looking for short-term return want a high dividend yield
Comparison between the cost of the shares and the divided received
Can be improved by increasing
the proportion of profits that are paid out as dividends
Depends on share price which can go up or down depending on business performance
Dividend per share
Shareholders looking for LONG-TERM return through capital gain might be happy with a low dividend per share
Shareholders looking for SHORT-TERM return want the dividend per share to be as high as possible
Resulting figure is usually expressed as a number of pence
Usually stated at the foot of the income statement appropriation account
Gearing ratio
Crude risk assessment that an investor can use to help decide whether to buy shares in the company
Gearing of below 50% shows it’s
low-geared as less than half of the finance comes from loans
Gearing above 50% shows that more than half of a business’ finance comes from loans
- business is high-geared
Calculated using info from the
lower part of a balance sheet
Shows potential investors where a business’ finance has come from
