Chapter 12 - Accounting Ratios, Ratio Analysis and Business Performance

Question 1

Ratio Analysis

Answer 1

Ratio analysis enables users to identify areas of financial strength and weaknesses of the organisation

Question 2

Profitability Ratios

Answer 2

Net Profit Ratio
Operating Profit Margin
Gross Profit Ration
ROCE

Question 3

Profitability ratios

Net Ratio Formula

Answer 3

net profit (profit before tax)/ sales revenue x 100 = %

The result is a percentage

Question 4

Profitability Ratios

Operating Profit Ratio

Answer 4

PBIT / sales revenue x 100 = %

PBIT: profit before interest and tax, it is the same as the operating profit

Question 5

Profitability Ratios

Gross Profit

Answer 5

Gross profit / sales revenue x 100 = %

Question 6

Profitability Ratios

ROCE (return on capital employed)

Answer 6

Operating Profit / capital employed x 100 = %

Question 7

Liquidity Ratios

Answer 7

Current Ratio
Acid Test Ratio (or quick ratio)
Financial Gearing
Finance Costs Cover

Question 8

Liquidity Ratios

Current Ratio

Answer 8

current assets / current liabilities = :1

Question 9

Liquidity Ratios

Acid Test (Quick Ratio)

Answer 9

Current assets (excluding inventory) / current liabilities = :1

Question 10

Liquidity Ratios

Financial Gearing

Answer 10

non current liabilities / capital employed x 100 = %

Question 11

Liquidity Ratios

Finance Costs Cover

Answer 11

Operating profit / finance costs = times

Question 12

Efficiency Ratios

Answer 12

Inventory Turnover
Receivables collection period
Payables settlement period
Return of Sales on Assets Employed

Question 13

Efficiency Ratios

Inventory Turnover

Answer 13

Average Inventory / cost of sales x 365 = days

Question 14

Efficiency Ratios

Sales Collections Period

Answer 14

Receivables / Sales revenue x 365 = days

Question 15

Efficiency Ratios

Payables Settlement Period

Answer 15

Payables / Purchases x 365 = days

Question 16

Efficiency Ratios

Return of Sales in Assets Employed

Answer 16

Sales revenue / net assets = times

Question 17

Working Capital Formula

Answer 17

Current Assets - Current Liabilities = £

Question 18

Cash Operating Cycle

Answer 18

Inventory Turnover Rate + Receivables Collection Period - Payables Settlement Period

Question 19

Usefulness of Profitability Rations

Gross Profit

Answer 19

gross profit / sales revenue x 100

Gross Profit is the sales revenue minus the cost of sales in the Income Statement.

this ratio shows the amount of gross profit made from sales, in a percentage result.

Improved performance will reflect an increase in this ratio.
Ratio will shrink due to:
- reduction in selling price
- increase on the cost of sales, without an increase in the prices
- greater wastage, poor inventory control, theft of goods

Question 20

Usefulness of Profitability Rations

Operating Profit Margin

Answer 20

PBIT / Sales Revenue x 100 = %

This is the profit before finance costs and taxation. That is, it is the profit after all overheads and expenses were deducted (but not the finance costs, which are the cost of funding, and generally not connected to day to day life).

It measures the margin of profit between the actual operation activity of the firm and the selling price of the goods, and measures the capacity of the company in buying and selling, and controlling expenses.

Improved performance will improve this ratio. Decrease will occur if:

• a rise in the organisation’s expenses and overheads, without a corresponding increase in selling price;
• higher day to day costs (utilities, labour, premises);
• poor budgetary control when it comes to expenses, resulting in overspending.