Chapter 9 - Financial ratios

Question 1

The standard ratios fall into which five categories?

Answer 1

profitability ratios
productivity ratios
liquidity ratios
activity or turnover ratios
gearing ratios

Question 2

What are the three main profitability ratios?

Answer 2

gross profit percentage
net profit percentage
return on capital employed

Question 3

What is the formula for the gross profit percentage ratio?

Answer 3

Gross profit / sales (revenue) x 100

Question 4

What can a decrease in the gross profit percentage show?

Answer 4

May indicate greater competition in the market, causing lower selling prices and a lower gross profit or increase in cost of purchases

Question 5

What can an increase in the gross profit percentage show?

Answer 5

May indicate the company is in a position to exploit the market and charge higher prices for its products.

Question 6

The third final change in the gross profit percentage ratio may indicate?

Answer 6

A change in the mix of products sold.

Question 7

What is the net profit percentage ratio?

Answer 7

Net profit / sales (revenue or turnover) x 100

Question 8

The relationship between the gross profit and net profit percentage gives an indication as to how well a company is managing its business…

Answer 8

Expenses

Question 9

If net profit has decreased over time, yet gross profit has remained the same, what may this indicate?

Answer 9

A lack of control over expenses

Question 10

As the net profit percentage ratio is shown as a percentage, this may show how effective the m……….

Answer 10

Management is

Question 11

If the net profit percentage margin is low then this could be caused by the business deliberately increasing the overheads to cope with a planned future…

Answer 11

Expansion of the business

Question 12

What is the return on capital employed formulae?

Answer 12

ROCE = profit before interest charges and tax / share capital + reserves + borrowings x 100

Question 13

The ROCE ratio enables an investor to see if…

Answer 13

The insurer is making money for them

Question 14

The ROCE ratio is basically concerned with the relationship of profit to the capital employed and is seen as giving an indication of how efficiently and effectively management have…

Answer 14

Deployed resources available to it

Question 15

As a rough guide to ROCE, a shareholder will want at least two times the return than if they was to…

Answer 15

Put their money in a typical bank deposit account

Question 16

The higher the risk in the company the higher the…

Answer 16

Return

Question 17

When a company is acquiring other businesses or moving into new markets, the ROCE should be ???? To make it worthwhile for capital providers

Answer 17

High

Question 18

Both profitability and productivity compare inputs and …

Answer 18

outputs

Question 19

Profitability compares the money value of the outputs with the money value of the inputs. The difference between the two is profit. The difference in productivity is that…

Answer 19

It does not use money as a measure. It compares inputs and outputs directly

Question 20

What are liquid assets?

Answer 20

All the assets that are money (cash) or can be turned into cash at short notice

Question 21

In regards to liquidity ratios, what are the two most important ratios? (Think snappy)

Answer 21

Current ratio and the quick ratio

Question 22

What is the formulae for the current ratio?

Answer 22

Current assets / current liabilities

Question 23

What is the formulae for the quick ratio?

Answer 23

Current assets excluding stock / current liabilities

Question 24

What are ROCE ratio an important measure?

Answer 24

Why the ROCE ratio is an important measure:
* A low return could easily be wiped out in a recession.
* When acquiring other businesses or moving into new markets, there should be a high ROCE to make it worthwhile for the capital providers.
* A persistently low ROCE in a business division may signal that it is time to dispose of it.

Question 25

What do we mean by gearing ratio?

Answer 25

It is a measure of financial leverage and shows the extent to which a company finances its activities from borrowings as opposed to shareholders’ equity. The higher this ratio, the more the business in question relies on debt finance.

Question 26

What is the gearing ratio?

Answer 26

long-term borrowings / shareholders’ equity × 100

Question 27

What ratios are used in the insurance industry?

Answer 27

• solvency;
• liquidity;
• capital adequacy;
• profitability; and
• outstanding claims

Question 28

What is the solvency ratio?

Answer 28

The solvency coverage ratio compares the total eligible capital to the solvency capital requirement.

total eligible capital / solvency capital requirement

Question 29

What is the liquidity ratio in insurance?

Answer 29

total liabilities / cash + Investments

Question 30

What is the combined ratio?

Answer 30

The three ratios that drive the combined ratio are:
* the claims ratio: = claims incurred net of reinsurance / earned premium net of reinsurance × 100

• the expense ratio: = administrative expenses / earned premium net of reinsurance × 100
• the commission ratio: = acquisition costs / earned premium net of reinsurance × 100

Together these three ratios form the combined ratio:

• the combined (or operating) ratio: = claims+expenses + acquisition costs / earned premium net of reinsurance × 100

Question 31

What are ratios used for?

Answer 31

Ratios are used to analyse a company’s results as they aid comparability from one company to another and for the same company over a period of time.

Question 32

Which ratio would help to establish that an insurance company was receiving enough premium to cover the costs of claims and expenses?

Answer 32

The combined ratio, which measures the underwriting performance by combining the loss ratio with the expense ratio and the commission ratio.

Question 33

What can change the gross profit percentage ratio?

Answer 33

A decrease may indicate greater competition in the market causing lower selling prices

An increase in the gross profit percentage may indicate that the company is in a position
to exploit the market and charge higher prices for its products

A change can also be due to a change in the mix of products sold. An increasing volume
of a product with a high gross margin will increase the overall ratio.

Question 34

What does a highly geared ratio show?

Answer 34

A highly geared ratio may suggest that a company cannot finance its own activities.