Ch 25- Assessing the business

Question 1

What are the 3 factors used when assessing a business?

Answer 1

-Profitability
-Liquidity
-Gearing

Question 2

What are the 3 calculations to assess the profitability of a business? (Names only)

Answer 2

-Gross profit percentage
-Net profit percentage

Only used sometimes: ROC

Question 3

What is the gross profit percentage calculation?

Answer 3

Gross Profit
—————- x 100
Sales

Question 4

What is the net profit percentage calculation?

Answer 4

Net Profit
————– x 100
Sales

Question 5

What is the ROC calculation?

Answer 5

Net Profit
————————- x 100
Capital employed

Question 6

How do you know if a companys profitability is good?

Answer 6

Their calculations should steadily increase each year
(If question does not give 2 years say- The company should compare to other years to ensure a steady rise)

Question 7

What is ROC?

Answer 7

Return On Capital employed
-it is the money invested compared to profit

-It should be higher than competitors and be higher than the interest rate available on deposit accounts (idk if we need this)

Question 8

What are the 2 calculations to assess the liquidity of a business? (Names only)

Answer 8

-Current ratio
-Acid test ratio

Question 9

What does liquidity assess?

Answer 9

(Also known as solvency)
Assesses how easily a business can pay its short-term bills

Question 10

What is insolvency?

Answer 10

When total liabilities exceed total assets (A business is unable to pay its debts)

Question 11

What is liquidation?

Answer 11

When a business is closed down and its assets are sold off

Question 12

What is the current ratio?
How do you know if a businesses current ratio is good?

Answer 12

-A firms ability to pay its current liabilities
Current assets
———————— (whatever it is :1, e.g. 2:1)
Current liabilities

-It should be at least 2:1, and increase from year to year

Question 13

What is the acid test ratio?
How do you know if a businesses acid test ratio is good?

Answer 13

• A businesses ability to raise cash quickly to meet its current liability debts

Current Assets - Closing Stock
——————————————- (whatever it is :1, e.g. 2:1)
Current Liabilities

-It should be at least 1:1, and increase from year to year

Question 14

What is gearing?

Answer 14

How much long-term debt has been borrowed compared to how much equity finance has been invested by owners
(known as leverage)

Question 15

How do you calculate gearing?
How do you know if its high gearing or low gearing?

Answer 15

Debt capital
—————– x 100
Equity capital (reserves)

Low gearing- less than 50%
High gearing- more than 50%

Question 16

What does it mean if you have low gearing?

Answer 16

-Relatively small long-term loans
-Low risk
-Shareholders open to invest
-Banks more likely to accept loans

Question 17

What does it mean if you have high gearing?

Answer 17

-Relatively large long-term loans
-High risk

Question 18

Why does high gearing cause problems?

Answer 18

-Greater pressure on management to increase profit
-Greater difficulty raising finance as banks are less likely to provide finance
-Shareholders less likely to invest
-Risk of liquidation