Chapter 9 - Financial ratios Flashcards
The standard ratios fall into which five categories?
profitability ratios
productivity ratios
liquidity ratios
activity or turnover ratios
gearing ratios
What are the three main profitability ratios?
gross profit percentage
net profit percentage
return on capital employed
What is the formula for the gross profit percentage ratio?
Gross profit / sales (revenue) x 100
What can a decrease in the gross profit percentage show?
May indicate greater competition in the market, causing lower selling prices and a lower gross profit or increase in cost of purchases
What can an increase in the gross profit percentage show?
May indicate the company is in a position to exploit the market and charge higher prices for its products.
The third final change in the gross profit percentage ratio may indicate?
A change in the mix of products sold.
What is the net profit percentage ratio?
Net profit / sales (revenue or turnover) x 100
The relationship between the gross profit and net profit percentage gives an indication as to how well a company is managing its business…
Expenses
If net profit has decreased over time, yet gross profit has remained the same, what may this indicate?
A lack of control over expenses
As the net profit percentage ratio is shown as a percentage, this may show how effective the m……….
Management is
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…
Expansion of the business
What is the return on capital employed formulae?
ROCE = profit before interest charges and tax / share capital + reserves + borrowings x 100
The ROCE ratio enables an investor to see if…
The insurer is making money for them
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…
Deployed resources available to it
As a rough guide to ROCE, a shareholder will want at least two times the return than if they was to…
Put their money in a typical bank deposit account
The higher the risk in the company the higher the…
Return
When a company is acquiring other businesses or moving into new markets, the ROCE should be ???? To make it worthwhile for capital providers
High
Both profitability and productivity compare inputs and …
outputs
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…
It does not use money as a measure. It compares inputs and outputs directly
What are liquid assets?
All the assets that are money (cash) or can be turned into cash at short notice
In regards to liquidity ratios, what are the two most important ratios? (Think snappy)
Current ratio and the quick ratio
What is the formulae for the current ratio?
Current assets / current liabilities
What is the formulae for the quick ratio?
Current assets excluding stock / current liabilities
What are ROCE ratio an important measure?
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.
What do we mean by gearing ratio?
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.
What is the gearing ratio?
long-term borrowings / shareholders’ equity × 100
What ratios are used in the insurance industry?
- solvency;
- liquidity;
- capital adequacy;
- profitability; and
- outstanding claims
What is the solvency ratio?
The solvency coverage ratio compares the total eligible capital to the solvency capital requirement.
total eligible capital / solvency capital requirement
What is the liquidity ratio in insurance?
total liabilities / cash + Investments
What is the combined ratio?
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
What are ratios used for?
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.
Which ratio would help to establish that an insurance company was receiving enough premium to cover the costs of claims and expenses?
The combined ratio, which measures the underwriting performance by combining the loss ratio with the expense ratio and the commission ratio.
What can change the gross profit percentage ratio?
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.
What does a highly geared ratio show?
A highly geared ratio may suggest that a company cannot finance its own activities.
