financial accounting - ratio analysis Flashcards
how to calculate current ratio?
current assets ÷ current liabilities
how to calculate acid test ratio?
(current assets - stock) ÷ current liabilities
what value do you want the current ratio to be?
1.5 is ideal, but generally depends on the business
below 1 raises concerns –> insufficient assets to cover liabilities
what value do you want the acid ratio to be?
significantly less than 1 is bad
why are ratios useful?
- comparisons can be made
- stakeholders can assess whether investment is worth it
- management can use them for a measure of performance
- employees can see for job certainty
- find problems to solve
what are the limitations of ratios?
- inflation may distort figures e.g. revenue, profit and return
- state of economy may mean a fall in certain ratios
- calculations are made the same way over time so comparisons may not be accurate
- external factors may distort figures outside control of business
- no set benchmarks for judging ratios
how to calculate GPM (gross profit margin)?
(gross profit÷sales revenue) x 100
how to calculate NPM (net profit margin)?
(operating profit÷sales revenue) x 100
how to calculate Return on capital employed (ROCE)?
(operating profit÷(total equity+non-current liabilities)) x 100
how to calculate return on equity?
(operating profit÷total equity) x 100
what does GMP and NPM tell you?
how many pence from every pound of sales is gross profit
e.g. 40% = for every £1 of sales, 40p is GP
why is ROCE useful?
- evaluate overall performance
- provide a target return for individual target
- benchmark performance with competitors
why is ROCE limited?
- based on snapshot of business’ balance sheet
- varies between industries
