Chapter 26 Flashcards
What is analysis of accounts?
Interpreting all of the financial accounts documents to see how well a business is doing and rate its performance compared to previous years and competitors
What are the two types of ratios?
Ratios: quantitative analysis of financial information of a business
Profitability: measure of profit made relative to the value of sales or capital employed of a company.
Liquidity: the ability of a business to passes short-term debts.
What are the 3 profitability ratios?
- Gross profit margin
-Net profit margin - return on capital employed (ROCE)
Must use all ratios together
what is return on capital employed?
shows how efficiently a company is in converting their capital investment into profits. this compares net operating profit to capital employed. shows how effectively assets are at performing while taking into consideration long term financing (long term ratio). higher the ROCE, better profitability for investors and the business
net operating profit/ capital employed (OR total assets-current liabilities)
what is gross profit margin?
shows the percentage of revenue that exceeds the costs of the goods that were sold. this shows how successful the company’s management team is in generating revenue from costs. high the number, more efficient the management is
revenue-cost of goods sold / revenue x 100
what is net profit margin?
percentage of revenue remaining after all costs (including fixed costs) are subtracted
net income / total sales
what are the 2 liquidity ratios?
current ratio and acid test ratio
what is current ratio?
calculates how many current assets are there in proportion to every current liability. higher the current ratio the better. (above 1.5)
current assets / current liabilities
what is acid test ratio?
similar to current ratio but it does not consider inventories as a liquid asset since it takes time for them to be sold and converted into cash. having a high inventory level can mean that the company is illiquid as they are hard to convert to cash. this sees if the business is likely to survive in the future. (should be above 1) (cash sales - 0.75)
current assets - inventories / current liabilities
who are the users of accounting information?
managers, shareholders, creditors, banks, government, workers and trade unions, competitors
why do managers use?
identify which business aspect is doing well and which is not which can lead to redundancy to save costs, help decision making, keep control over the performance of each product, can compare with competitors and previous accounts
why do shareholders use?
potential investors and shareholders will want to know how profitable the company is. they can see how many shares they need to buy, and can know the worth of the business
why do creditors use?
shows the total amount of debts the business needs to pay back, the cash position, and liquidity ratios indicate the company’s ability to pay back its debts
why do banks use
ensuring the company is not illiquid and can pay back the loans
why does the government use?
to see if the company is paying the right taxes and to check tax revenue
