Chapter 11 Flashcards
What are the 4 categories for ratio analysis?
Profitability
Liquidity
Use of resources
Financial Position
What can we compare ratios to?
Previous year financial statements
Forecasted financial statements
Financial statements of another company
Average figures for the whole industry
What is the formula for gross profit Margin / percentage?
(Gross profit / revenue) x 100
What can gross profit % tell you about a business?
Should be similar year on year, any significant changes (especially a decrease) should be investigated.
Inventory cut off procedures should also be investigated, as incorrect inventory will impact gross profit twice.
How to calculate operating profit percentage?
(Profit from operations / Revenue) x 100
What is operating profit % and what does it tell you?
Profit from operations is profit before finance costs and tax. Avoids distortion when comparisons are made between 2 companies when one is heavily financed and the other is not.
How to calculate Expense / Revenue %?
(Specified expense / revenue) x100
Why is the expense / revenue percentage formula useful?
Useful for seeing how an expense has been affected by growth in sales from one year to the next, or for comparing the cost control of 2 different companies.
How to calculate Return on Capital Employed (ROCE)?
(Profit from operations / total equity + non current liabilities) x 100
Why is ROCE useful / what does it show?
Expresses the profit of a company in relation to the capital employed to generate it. Returns is best compared to another investment eg interest rate for bank
CAREFUL FOR COMPARING ACROSS INDUSTRIES - NO DIRECT COMPARISON
How to calculate return on equity?
(Profit after tax / total equity) x100
What does ROE ratio show / how is it useful?
Focuses on the return for ordinary shareholders.
What are the 5 profitability ratios?
Gross profit percentage Operating profit percentage Expense / revenue percentage Return on capital employed (ROCE) Return on Equity (ROE)
What are the liquidity ratios?
Current ratio (working capital ratio)
Acid test (quick) ratio
What is the formula for current (working capital) ratio?
Current assets / current liabilities = X:1
Generally Expect around 2:1
How is the current ratio useful / what does it show?
Measures the relationship between current assets and current liabilities. Should not operate at a level too low so that it’s assets do not cover debts. Equally, too high of a ratio may suggest the company has too much inventory, recievables or cash.
How to calculate the acid test (quick) ratio?
(Current assets - inventories / current liabilities)
How is the acid test / quick ratio useful : what does it show?
Omits inventories as they are the least liquid current asset that a company has, as it has to be sold, turned into receiveables and then cash received.
Ratio of less than 1:1 could indicate a company has difficulty paying its debts as they fall due.
Formula for inventory holding period in days?
(Inventories / Cost of Sales) x 365
What is inventory holding period, how is it useful / what does it show?
Number of days that inventory is held by a company on avg. Aside from certain industries most companies should aim for as lower days as possible, as well as being able to meet customer demands.
How to measure inventory turn over (in times per year)?
Cost of sales / inventories
What does inventory turn over show?
Show on average how many times per year a company is able to sell its total inventory in a year. Should aim for this to be high.
How to calculate trade receivables collection period (days)?
(Trade receivables / revenue) x 365
What does trade receivables collection period show?
Shows on average how many days it takes for debtors to settle their account balance with the company. Should only be compared with that of the previous year or against a similar company.
How to calculate trade payables payment period?
(Trade payables / cost of sales) x365
What does the trade payables payment period show / tell us?
Shows the time it takes for the company to settle its payable balances.
Delaying payment too long can lead to operational problems. But it is a valuable source of short-term finance.
Working capital cycle calculation?
Inventory days + receivable days - payables days
Net assets turnover ratio calculation?
Revenue / total assets - current liabilities
What does the net assets turnover calculation show?
Measures the efficiency of the use of key assets in generating revenue. A measure of the number of pounds of revenue generated per pound of net assets invested in the company.
Ideal value for asset turnover?
Ideally increasing but need to be careful of assumptions - could have bought lots of assets late i. The year and not had time to start generating revenue yet. Eg timing issues will impact this calculation
What is the asset turnover for total assets calculation?
Revenues / total assets
What is interest cover calculation?
Profit from operations / finance costs
Why is interest cover calc important / what does it show?
Considers the number of times a company could pay its interest payment using its profit from operations
What is the gearing formula?
( non current liabilities / total equity + non current liabilities ) x100
What does the gearing of a company show?
Concerned with long term financial stability of a company. Looks at how much the company is financed by debts. The higher the gearing ratio - the less secure the financing and thus the companies future.
