Financial Analysis - Ratios Flashcards
What are 3 ways you can analyse financial ratios?
Comparing performance over time
Comparing performance against competitors or industry.
Benchmarking against best-in-class businesses
What is the danger of comparing performance in just one year?
Could hide a longer-term issue
What is the positive of looking at performance over several years?
Possible to see whether a trend is emerging
What does comparing performance against competitors provide?
A useful way for managers and shareholders to assess performance
What is benchmarking?
Comparison against other businesses that are not direct competition
How is benchmarking helpful?
Helps set the standard that the business aims to achieve
Who is analysing Return-on-capital-employed useful for?
Large organisations with more significant capital investment
What does analysing ROCE not take into account?
Other functional factors or market value of assets
Why is analysing current ratio useful?
When assessing ability to pay short term debt
What is current ratio dependent on?
the valuation of stock and turnover expectation
What does high gearing mean?
Company owes more than it owns
What does it mean in terms of shareholders if high gearing?
Fewer shareholders so more control of decisions
What does low gearing mean?
Company owns more than it owes
What does inventory turnover depend on?
Nature of the product e.g perishability
What does the liquidity of an asset mean?
How easily it can be turned into cash and used to buy things
What is a business if they don’t have enough current assets to pay its liabilities when they are due?
Insolvent
How can liquidity be improved?
2 things
Decreasing stock levels
Slowing down payments to creditors
What does a liquidity ratio show?
How solvent a business is
How do you calculate current ratio?
Current assets divided by current liabilities
What is the ideal current ratio?
2:1
What does a profitability ratio show?
Profit margin
How is ROCE calculated?
Operating profit divided by capital employed X100
How do you calculate capital employed?
Total assets minus current liabilities
What does the ROCE tell you?
How much money is made by the business compared to how much money has been put into the business
What is a good ROCE?
Higher the better
How can ROCE be improved?
By paying off debt to reduce non-current liabilities
What do efficiency ratios show managers and shareholders?
How well the business is using its resources
What does high gearing mean? In detail
High level of debt (long-term) vs equity on its capital employed
How can a company benefit from high gearing?
In periods of low interest rates
What does low gearing mean for interest payments on loans?
Limits it so if rates are high, this maximises profit
What does inventory held for depend on?
On the industry
What does inventory turnover mean?
Shows how many times a company has sold or replaced inventory in a given period
What do some businesses do for high inventory turnover?
JIT
What are receiveable days?
Average length of time taken by customers to pay amounts owed
Why is it best to have low receiveable days?
Helps cash flow and working capital
What can you compare receiveable days ratios with?
Previous months or years to look for trends
What does aged receiveables analysis let managers do?
Control receiveables days
What does gearing show potential investors?
Where a business’s finance has come from
What is a high gearing?
Over 50%
How does gearing show how vulnerable a business is to changes in interest rates?
The more the business is borrowing, harder they will be hit by interest rates
What does a high gearing tell you? 2 points
More than half of the business’s finance comes from long-term debt
Willing to take risks
What does a low gearing tell you? 2 points
Most long-term funds come from shareholders and not borrowing
Risk averse
What are 2 rewards of being a high-geared business?
Extra funds for expansion
When interest rates are low, high gearing is less risky
What are 2 risks of being a high-geared business?
Might not be able to afford the repayments
Can be risky due to interest rates
What is the reward for shareholders if you have a high gearing?
Shareholders may expect higher dividends and a big increase in share price - could sell shares for profit
What is the risk for shareholders if you have a high gearing?
Business may fail if can’t keep up with repayments and shareholders can lose all money they have invested.
Why are ratios a good way at looking at performance over-time?
Used to spot trends and strengths and weaknesses
What are 2 disadvantages with financial ratios?
External factors aren’t reflected
Only contain info about past and present
What are payables days?
Average length of time taken by a business to pay amounts it owes
What can a high figure of payables suggest?
Liquidity problems
Is it better to have a higher or lower figure for payable days?
Higher figure is Better because the longer it takes means that there is cash in the bank which is good for cash flow.
