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Acccounting & Finance > Chapter 6 > Flashcards

Chapter 6 Flashcards

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1
Q

What are financial ratios?

A

A ratio is a relationship between two or more items in the financial statements (for example, net profit in relation to total assets).
Ratio analysis is a traditional tool for assessing the financial health of companies.

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2
Q

What are the 5 financial ratio classifications?

A

1) Profitability
2) Liquidity
3) Efficiency
4) Financial gearing
5) Investment

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3
Q

What is the purpose of profitability ratios?

A

Businesses generally exist with the primary purpose of creating wealth for their owners. Profitability ratios provide an insight to the degree of success in achieving this purpose.

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4
Q

What 4 ratios may be used to measure profitability?

A

1.1 Gross profit margin
1.2 Operating profit margin
1.3 Return on ordinary shareholders’ funds (ROSF)
1.4 Return on capital employed (ROCE

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5
Q

How would you calculate gross profit margins?

A
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6
Q

How would you calculate operating profit margin

A
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7
Q

How would you calculate Return on ordinary shareholders’ funds (ROSF)

A
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8
Q

How would you calculate Return on capital employed?

A
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9
Q

What do liquidity ratios measure?

A

Liquidity ratios are concerned with the ability of the business to meet its short-term financial obligations. Companies can only survive if they can pay their bills.

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10
Q

What are the two main liquidity ratios?

A

2.1 Current ratio
2.2 Quick ratio (Acid Test ratio)

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11
Q

How do you calculate current ratio

A
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12
Q

How do you calculate quick ratio or acid test ratio?

A
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13
Q

What do efficiency ratios measure?

A

Efficiency ratios measure the efficiency/ success of how particular resources have been used within the business. These ratios are also referred to as activity ratios.
• Companies which are doing well tend to have better efficiency ratios.

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14
Q

What are the four most common efficiency ratios?

A

3.1 Inventories turnover period
3.2 Settlement period for trade receivables
3.3 Settlement period for trade payables
3.4 Sales revenue per employee

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15
Q

How do you calculate Inventories turnover period?

A
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16
Q

How do you calculate Settlement period for trade receivables

A
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17
Q

How do you calculate Settlement period for trade payables

A
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18
Q

How do you calculate sales revenue per employee?

A
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19
Q

What is the Gearing ratio

A
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20
Q

What is the Interest cover ratio

A
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21
Q
  1. Return on ordinaryshareholders’ funds (ROSF) is within which one of the following groups ofratios?
    a) Liquidity
    b) Profitability
    c) Investment
    d) Efficiency
A

B) Profitability

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22
Q
  1. The return on capital employed (ROCE) shows how “solvent” a company is
    A) True
    B) False
A

B) False

23
Q
  1. One way to improve return on capital employed (ROCE) is to reduce costs and increase sales
    A) True
    B) False
A

A) True

24
Q
  1. The gross profit margin ratio is calculated according to which one of the following formulae?
    a) Gross profit divided by share capital (as a percentage)
    b) Gross profit divided by purchases (as a percentage)
    c) Gross profit divided by cost of sales (as a percentage)
    d) Gross profit divided by sales revenue (as a percentage)
A

D) Gross profit divided by sales revenue (as a percentage)

25
Q
  1. A measure of a corporation’s profitability that is required to be reported as part of the incon statement is the:
    a) Earnings per share
    b) Sales revenue per employee
    c) ROCE
    d) Gross profit margin
A

A) Earnings per share

26
Q
  1. Inventory is an example of a quick asset.
    a) True
    b) False
A

B) False

27
Q
  1. The lower the current ratio, the more liquid the company appears.
    a) True
    b) False
A

B) False

28
Q
  1. Which of the following statements about the current ratio is false?
    a) It is determined by dividing current assets by current liabilities
    b) A firm with a lower current ratio is better off than one with a higher current ratio
    c) The higher the current ratio, the more liquid the business is considered to be.
    d) It is larger than the quick ratio
A

b) A firm with a lower current ratio is better off than one with a higher current ratio

29
Q
  1. The current ratio will be ____ the quick ratio
    a) less than
    b) greater than or equal to
    c) the same as
    d) always different than
A

b) greater than or equal to

30
Q
  1. The acid test ratio is normally defined as current assets (excluding inventory) divided by which one of the following?
    a) Non-current assets
    b) Working capital
    c) Non-current liabilities
    d) Current liabilities
A

d) Current liabilities

31
Q
  1. Short-term creditors are most likely to use the quick ratio instead of the current ratio in evaluating the solvency of a company with large, slow-moving:
    A) Plant and equipment.
    b) Receivables.
    c) Inventories.
    d) Employees.
A

C) Inventories

32
Q
  1. Which of the following ratios considers the relationship between inventory and cost of sales?
    a) Average settlement period for payables
    b) Sales revenue to capital employed
    c) Inventory turnover ratio
    d) Average settlement period for receivables
A

c) Inventory turnover ratio

33
Q

If a company was interested in calculating how long it takes to receive money from customers, which of the calculations would they make?
a) Trade receivables / credit sales revenue x 365
b) Credit sales revenue / Trade receivables x 365
c) Trade payables / Cost of sales x 365
d) Cost of sales / Trade payables x 365

A

a) Trade receivables / credit sales revenue x 365

34
Q

If a supplier was interested in whether or not they will be paid on time, which of the calculations would rey make?
a) Trade receivables / credit sales revenue x 365
b) Credit sales revenue / Trade receivables x 365
c) Trade payables / Cost of sales x 365
d) Cost of sales / Trade payables x 365

A

c) Trade payables / Cost of sales x 365

35
Q
A
36
Q

If a company has a current ratio of 2, and purchases equipment on credit for 3 months, what will this do to its current ratio?
a) Increase the current ratio.
b) Decrease the current ratio.
c) Does not change the current ratio.
d) Cannot be determined.

A

B

Purchases equipment on credit for 3 months will increase current liabilities, the denominator of the ratio, thereby decreasing the current ratio.

37
Q
A

C

Correcting the error will lead to a decrease in short-term loan (current liabilities), thereby decreasing the Acid-test ratio. It will also lead to an increase in non-current liabilities, thereby decreasing the return on capital employed ratio.

38
Q
  1. Morland It had credit sales for the year of £705,000. If the average settlement period for trade receivables for the year was 146 days, what were the trade receivables for the year?
    A) 131,000
    B) 240,000
    C) 282.000
    D) 300,000
A
39
Q
A

A

Correcting the error will lead to a decrease in current assets, thereby decreasing the current ratio. It will also lead to a decrease in operating profits, thereby decreasing the interest cover ratio.

40
Q
A
41
Q
A

C

42
Q
A
43
Q

What are gearing ratios

A
44
Q

What are the two gearing ratios

A
45
Q

What are the four investment ratios

A
46
Q

What is the earnings per share ratio

A
47
Q

What is the Price / earnings ratio

A
48
Q

What is the dividend per share ratio

A
49
Q

What is the divided yield ratio

A
50
Q

Benefits of ratios

A
51
Q

Limitations of ratios

A
52
Q

How do you calculate owners equity

A

Owners equity = current assets - current liabilities

53
Q

How do you calculate total equity

A

Acccounting & Finance (8 decks)

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