Chapter 17

Question 1

What do management and analysts use ratios for?

Answer 1

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

Question 2

What are the three major categories of profitability?

Answer 2

Profitability
Liquidity
Risk

Question 3

What is profitability? (wordy)

Answer 3

How profitable is a company?
How well is a company run?
What return can shareholders expect?

Question 4

Profitability metrics

Answer 4

Gross profit margin
operating profit margin
net profit margin
Return on capital employed
Asset turnover

Question 5

What is liquidity? (wordy)

Answer 5

How easily can a company meet its debts and obligations?
How effectively can a company manage its working capital?

Question 6

Liquidity metrics

Answer 6

Current ratio
Quick ratio
Receivables collection period
Payables payment period
Inventory turnover

Question 7

What is risk? (wordy)

Answer 7

How much borrowing does a company have?
Can it meet its interest payments?

Question 8

Risk metrics

Answer 8

Gearing
Interest cover

Question 9

EQN: Gross Profit Margin

Answer 9

Gross Profit/Revenue

result = percentage

Question 10

EQN: Operating Profit Margin

Answer 10

Operating profit (Before interest and tax - PBIT)/Revenue

Result = percentage

Question 11

EQN: Net profit margin

Answer 11

Net Profit (Before tax)/Revenue

Question 12

EQN: Asset turnover

Answer 12

Revenue/(total assts less current liabilities)

Revenue/TALCL(

Question 13

EQN Non-current asset turnover

Answer 13

Revenue/Non-current assets

Question 14

EQN Return on capital employed

Answer 14

ROCE = PBIT/TALCL

ROCE = Operating Profit Margin * Net Asset Turnover

Question 15

EQN: Working Capital

Answer 15

Current assets - Current Liabilities

Question 16

EQN Current ratio

Answer 16

Current assets/current liabilities

Question 17

EQN Quick ratio

Answer 17

(Current assets - Inventory)/Current liabilities

Question 18

EQN Receivables collection period

Answer 18

Trade receivables/Credit sales * 365

Question 19

EQN: Payables payment period

Answer 19

Trade payables/Credit purchases (or COS) * 365

Question 20

EQN: Inventory days

Answer 20

Inventories/COS * 365

Question 21

EQN: Inventory turnover

Answer 21

COS/Inventories

Question 22

EQN: Gearing ratio

Answer 22

Interest bearing debt (excl. overdraft, incl. Pref shares)/
TALCL (Equity + Non-current liabilities)

Question 23

EQN: Interest cover

Answer 23

PBIT/(Interest and finance costs)

Question 24

Detail: Gross profit margin - use, decrease meaning,

Answer 24

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)

Question 25

Detail: operating profit margin - A note about PBIT

Answer 25

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.

Question 26

What do operating or net profit margin reflect

Answer 26

can reflect how efficiently a business is being run, i.e. through controlled overheads or economies of scale

Question 27

Detail Asset Turnover

Question 28

Detail: Non-current asset turnover - what does it measure

Answer 28

how much sales revenue is generated for every $ of non-current assets employed