F2 - 15. Ratios Flashcards
What are the 3 key uses of accounting ratios?
- Highlight unusual results
- Clarify trends
- Make more informed decisions
What in particular is needed to make accounting ratios useful?
A comparator - prior year, vs budget, vs competitor
Who are the 4 main users of financial statements?
- Shareholders/potential investors
- Suppliers/lenders
- Employees
- Management
What 3 other things must accompany accounts to be useful?
- Events after the reporting period
- Accounting policies used and significant judgements made
- Impact of one off costs or transactions
What are the 4 profitability ratios?
- Gross profit
- Operating profit
- ROCE
- Asset turnover
What are the 5 liquidity ratios?
- Current ratio
- Quick ratio
- Receivables collection period
- Payables payment period
- Inventory turnover
What are the 3 gearing ratios?
- Gearing
- Debt to equity
- Interest cover
What is the use of gross profit margins?
Make pricing decisions, understand cost increases/price reductions
What is the use of operating profit margins?
Reflect how efficiently a business is being run, through overhead control or economies of scale
What is the use of net asset turnover?
See how much sales revenue is being generated for every £ of assets being employed
What is the use of ROCE?
See how much profit is being generated for every £ of assets being employed, how efficiently the company uses its assets
What is the use of ROE?
How much profit is generated for the shareholders for every £ of equity invested
What is the main advantage of high gearing?
Debt is cheaper than equity
- Interest is tax deductible
- Interest is fixed but profits grow
What are the 2 benefits of EBITDA?
- Improves comparability between different capital structures
- Removes non cash balances that could be influenced by bias
What are the 2 criticisms of EBITDA?
- Misunderstood as being a measure of cash flow
2. Used by some to publicise a higher measure of earnings
What are the 4 main limitations of ratio analysis?
- Based on historical information
- Different accounting policies make less comparable
- Inflation may distort performance over time
- Only look at financial information
What 5 things can distort comparisons between reporting entities?
- Accounting policies
- Seasonality
- Related party transactions
- Size
- Management policies e.g. leasing vs buying
What are the 4 main considerations when comparing entities in different countries?
- Different economic environments
- Interest rates
- Tax rates
- Government policies
