Chapter 17 Flashcards
What do management and analysts use ratios for?
To assess company performance.
Ratios can highlight areas that require further investigation
Can be used to compare to budgets, competitors, industry averages and prior periods
not very useful if not used with comparitives
What are the three major categories of profitability?
Profitability
Liquidity
Risk
What is profitability? (wordy)
How profitable is a company?
How well is a company run?
What return can shareholders expect?
Profitability metrics
Gross profit margin
operating profit margin
net profit margin
Return on capital employed
Asset turnover
What is liquidity? (wordy)
How easily can a company meet its debts and obligations?
How effectively can a company manage its working capital?
Liquidity metrics
Current ratio
Quick ratio
Receivables collection period
Payables payment period
Inventory turnover
What is risk? (wordy)
How much borrowing does a company have?
Can it meet its interest payments?
Risk metrics
Gearing
Interest cover
EQN: Gross Profit Margin
Gross Profit/Revenue
result = percentage
EQN: Operating Profit Margin
Operating profit (Before interest and tax - PBIT)/Revenue
Result = percentage
EQN: Net profit margin
Net Profit (Before tax)/Revenue
EQN: Asset turnover
Revenue/(total assts less current liabilities)
Revenue/TALCL(
EQN Non-current asset turnover
Revenue/Non-current assets
EQN Return on capital employed
ROCE = PBIT/TALCL
ROCE = Operating Profit Margin * Net Asset Turnover
EQN: Working Capital
Current assets - Current Liabilities
EQN Current ratio
Current assets/current liabilities
EQN Quick ratio
(Current assets - Inventory)/Current liabilities
EQN Receivables collection period
Trade receivables/Credit sales * 365
EQN: Payables payment period
Trade payables/Credit purchases (or COS) * 365
EQN: Inventory days
Inventories/COS * 365
EQN: Inventory turnover
COS/Inventories
EQN: Gearing ratio
Interest bearing debt (excl. overdraft, incl. Pref shares)/
TALCL (Equity + Non-current liabilities)
EQN: Interest cover
PBIT/(Interest and finance costs)
Detail: Gross profit margin - use, decrease meaning,
Use:
1) to make pricing decisions
increased selling price relative to direct costs will result in increased gross profit margin
2) to check that accounting policies are consistent
falling margin - probably due to increased costs or reduced prices (to buy market share)
Detail: operating profit margin - A note about PBIT
you need to be careful when calculating profit before interest and tax (PBIT). Most statements of profit or loss only give profit before tax so you will need to add back the interest charge.
What do operating or net profit margin reflect
can reflect how efficiently a business is being run, i.e. through controlled overheads or economies of scale
Detail Asset Turnover
Detail: Non-current asset turnover - what does it measure
how much sales revenue is generated for every $ of non-current assets employed
