Finance - Financial ratios

Question 1

Liquidity

Answer 1

Current ratio = current assets ÷ current liabilities
Generally preferred level ratio 2:1

Question 2

Profitability - gross profit

Answer 2

=Gross profit ÷ Sales

A high or at least increasing % is preferred but it depends on the industry

Question 3

Profitability - net profit ratio

Answer 3

=Net profit ÷ Sales

Increasing expenses over time will need closer review

Question 4

Profitability - return on equity ratio

Answer 4

=Net profit ÷ Total equity x100

The higher the return the better. Usually over 20% is a good return

Question 5

Gearing (solvency)

Answer 5

Debt to equity ratio = Total liabilities ÷ total equity x100

For a small business 60% is an acceptable level. The higher the % the greater the financial risk. Large companies may operate at over 100%.

Question 6

Efficiency - expense ratio

Answer 6

=Total expense ÷ sales

Suggested level depends on industry. Falling figures or a low figure compared to similar businesses would be a concern.

Question 7

Efficiency - accounts receivable turnover ratio

Answer 7

=Sales ÷ Accounts receivables

Standard time to repay credit is 14 - 30 day. If the accounts receivable rate is more than 10 days above the standard payment time, then the business should be concerned