Chapter 9 Flashcards
Are financial ratios required at law?
No
What do you use financial ratios for?
To understand more about the accounts/ the direction of the company/ can compare companies in the same sector
What are the two sets of ratios in chapter 9?
General ratios and insurers ratios
What is a profitability ratio measured in?
A percentage
What is a liquidity ratio measured in?
A number
What is days ratio measured in?
Days
What do activity ratios measure?
The same thing as productivity ratios but the opposite way round
What are profitability/ Non profitability ratios?
Gross profit percentage ratio
Net profit percentage ratio
Return on Capital employed (ROCE ratio)
What is a Gross Profit ratio
A profitability/ non- profitability ratio
Used for companies with stock only
Gross profit / sales (income/ turnover/ revenue) x 100
What happens if you have a decrease in the Gross Profit ratio
Not good.
What happens if there is an increase in the Gross profit ratio
Good. Can charge customers more/ better margin.
What is the Return on capital employed (ROCE) ratio?
A profitability ratio/ non profitability ratio
profit before interest charge and tax /
share capital + reserves + borrowings
x 100
Do you want the Return on capital employed ROCE high?
Yes. It means that you are showing shareholder money well. Outperforming bank interest rates etc.
The higher the risk the more shareholders will look for better returns on capital.
If you have a ratio of 5% it means you are making 5% on the money it’s been given from bank/ shareholders.
What is share capital?
he amount of money the owners of a company have invested in the business as represented by common and/or preferred shares
What is the net profit percentage ratio?
A profitability ratio/ non profitability ratio
Net profit/ sales (revenue/ turnover) x 100
If it increases over time it shows you have skilled management. If it decreases than the company may be deliberately increasing the overheads to coped with a future expansion
Why is Return on capital employed ROCE ratio an important measure
A low return could be wiped out in a recession
When aquiring a new company it should be high
A persistent low ROCE in a business division may signal its time to dispose of this division
What is a liquidity ratio?
Shows whether you’ve got enough current assets to meet your short term liabilities. Do you have enough liquid assets available?
With a liquidity ratio current ratio what figure should it be?
Above 1 at a bare minimum. 1.5 is normal. Below 1 you are a business heading towards bankruptcy. Your short term debt is higher than your short term assets (things you can turn quickly into cash)
What is the current ratio?
A liquidity ratio
current assets / current liabilities
What is the quick ratio
A liquidity ratio
current assets excl stock/ current liabilities
When will you use the liquidity quick ratio
When you are concerned whether the stock is turning over. When you have stock hanging around becoming obsolete.
What happens if the liquidity quick ratio is lower than one?
More obsolete stock which means they can’t sell their stock enough to meet their liabilities. Could go under.
What is the stock efficiency ratio?
An activity ratio
Cost of sales (purchases)/ closing stock
The lower the better. Measured in days. Want it to decrease. If the stock is turned over more slowly then the less cash is generated.
What is the gearing ratio? WILL COME UP
Shows where the company gets its money from
Long- term borrowings/ shareholders equity x 100
Will be a percentage
The higher the % the more the company relies on borrowing. If 110% ratio on the gearing ratio = long term borrowings is higher than shareholder funds so will be called a HIGH GEARED COMPANY. Reliance on long term borrowing.
What is the gearing ratio measured in? WILL COME UP
A percentage
Under the gearing ratio, if the long term borrowings is higher than its shareholder funds? WILL COME UP
its a high geared company- reliance on long term borrowing?
Under the gearing ratio, if the long term borrowings is a low percentage (15%/20%) WILL COME UP
low geared company. Get more from your shareholders than you do your banks.
A company has a gearing ratio of 25 to 50% what does it mean WILL COME UP
Normal.
A company has a gearing ratio of over 50% what does it mean WILL COME UP
High. - reliant on long term borrowing
Insurance industry ratios
What is the claims ratio
A %
Claims incurred net of reinsurance/ earned premium net of reinsurance x 100
No ideal % so will vary.
Insurance industry ratio.
What is the combined ratio?
It measures the underwriting performance - is there sufficient premium to cover the cost of claims and expenses?
Insurance industry ratio.
If a combined ratio is under 100% what does that mean?
A good underwriting performance rather than profitability. If it decreases its good.
Insurance industry ratio
If a combined ratio is over 110% what does that mean?
Poor underwriting and catastrophe losses
Insurance industry ratio
What are the three ratios that drive the combined ratio
The claims ratio.
The expenses ratio
The commissions ratio
Insurance industry ratio
What is the claims ratio to calculate the combined ratio
claims incurred net of reinsurance/ earned premium net of reinsurance x 100
Insurance industry ratio
What is the expenses ratio to calculate the combined ratio
administrative expenses (u/w, claims costs, offices/ earned premium net of reinsurance x 100
Ideally like it decreasing as it shows you have a control of expenses
Insurance industry ratio
What is the commission ratio to calculate the combined ratio
acquisition costs/ earned premium net of reinsurance x 100
Insurance industry ratio
How do you calculate the combined ratio
Claims ratio % + expenses ratio % + acquisition costs % / earned premium net of reinsurance x 100
A good combine ratio is the lower the better. Ideally below 100 at the very least as you’ve made underwriting profit.
Can an insurer make money where the combined ratio is over 100?
Yes, it all depends on the investment income. If this is higher than the claims loss you still make money.
What are the five frequently used ratios
Profitability ratios productivity ratios liquidity ratios activity ratios and gearing ratios
How do profitability ratios work
Compare percentage figures of sales to previous years
What does it mean if a net profit percentage has decreased while the gross profit percentage has remained the same
It might indicate a lack of internal control over expenses
What does the return on capital employed ratio enable an investor to see
Is the insurer is making money for them and make comparisons between companies
When acquiring other businesses are moving into new markets should There be a high return on capital employed ratio
Yes to make it worthwhile for the capital providers
What is profitability
It compares the money value of the output with the money value of the input the difference between the two is a profit
What is productivity
It compares input an output directly so does not use money as a measuring rod
Which ratio provides an indication of how successful the debt collection has been
Trade receivables, debtors/ sales x 365 days
What is a payables/creditors efficiency ratio
Payables/creditors divided by purchase x 365 days
which Ratio indicates the average number of days inventory/stock is held for
The inventory/stock turnover
Inventory, stock / cost of sales x 365 days
What does a lengthening in the inventory/stock turnover period indicate
Slowing down of trading all the necessary build a stock/inventory
Which ratio is all about showing how well a business is using the money they have been given regardless of the source
Return on capital employed ratio (ROCE)
What are liquid assets
Assets that are either money or can we turn into money at short notice for example a short-term loan
What is an example of a business that can trade with a low current ratio
Supermarket
What do activity ratios do
They compare some aspects of the companies activities (usually sales or purchases) with the relevant balance sheet item
What is the stock turnover ratio
Cost of sales/ average stock
Under the stock turnover ratio Ibstock it turned over more slowly what does that mean
Bad as less cash is generated and relatively more cash is tied up in stock
What is a debt turnover ratio
Sales/ debtors
What is the credit turnover ratio
Purchaes/ creditors
Under the credit turnover ratio what happened if there is an increase in the credit period
If it takes longer to pay suppliers effect the same if we borrowed more money to pay them the business had more liquidity that it would have otherwise
Which ratio is the best to measure a companies future
The gearing ratio
Insurance ratio
What is the solvency ratio
Net assets/ earned premium net of reinsurance
Insurance ratio
The higher the figure for the solvency ratio means what
The stronger the company
Insurance ratio
What is the solvency Coverage ratio
Surplus regulatory capital/ regulatory capital required
Insurance ratio
What is the liquidity ratio formula
Total liabilities/ cash plus investments
Insurance ratio
What is the return on equity ratio
Profit after tax/ shareholders equity x 100
Insurance ratio
By a rough guide the investor should be making what time is the amount on the return of equity ratio
2.5 times. The higher figure merging the better the return
What is the insurance gearing ratio
Long-term borrowings/ shareholders equity x 100
Is it common for insurer that chooses to use debt capital to have a gearing ratio in a range of 10 to 25%
yES
Insurance company with a gearing ratio below 10% would be regarded as what
Having a low level of gearing and above 40% as highly geared
Insurance ratio
What is the commission ratio
Acquisitions/commissions ratio divided by Earned premium net of reinsurance x 100
What is a good commission ratio
Usually between 10 to 20%
What is the outstanding claims ratio
Outstanding claims net of reinsurance/ Net assets
If the outstanding claims ratio is lower what does that mean
Below are the ratio of the more secure the position
