Financial Analysis - Ratios

Question 1

What are 3 ways you can analyse financial ratios?

Answer 1

Comparing performance over time
Comparing performance against competitors or industry.
Benchmarking against best-in-class businesses

Question 2

What is the danger of comparing performance in just one year?

Answer 2

Could hide a longer-term issue

Question 3

What is the positive of looking at performance over several years?

Answer 3

Possible to see whether a trend is emerging

Question 4

What does comparing performance against competitors provide?

Answer 4

A useful way for managers and shareholders to assess performance

Question 5

What is benchmarking?

Answer 5

Comparison against other businesses that are not direct competition

Question 6

How is benchmarking helpful?

Answer 6

Helps set the standard that the business aims to achieve

Question 7

Who is analysing Return-on-capital-employed useful for?

Answer 7

Large organisations with more significant capital investment

Question 8

What does analysing ROCE not take into account?

Answer 8

Other functional factors or market value of assets

Question 9

Why is analysing current ratio useful?

Answer 9

When assessing ability to pay short term debt

Question 10

What is current ratio dependent on?

Answer 10

the valuation of stock and turnover expectation

Question 11

What does high gearing mean?

Answer 11

Company owes more than it owns

Question 12

What does it mean in terms of shareholders if high gearing?

Answer 12

Fewer shareholders so more control of decisions

Question 13

What does low gearing mean?

Answer 13

Company owns more than it owes

Question 14

What does inventory turnover depend on?

Answer 14

Nature of the product e.g perishability

Question 15

What does the liquidity of an asset mean?

Answer 15

How easily it can be turned into cash and used to buy things

Question 16

What is a business if they don’t have enough current assets to pay its liabilities when they are due?

Answer 16

Insolvent

Question 17

How can liquidity be improved?
2 things

Answer 17

Decreasing stock levels
Slowing down payments to creditors

Question 18

What does a liquidity ratio show?

Answer 18

How solvent a business is

Question 19

How do you calculate current ratio?

Answer 19

Current assets divided by current liabilities

Question 20

What is the ideal current ratio?

Answer 20

2:1

Question 21

What does a profitability ratio show?

Answer 21

Profit margin

Question 22

How is ROCE calculated?

Answer 22

Operating profit divided by capital employed X100

Question 23

How do you calculate capital employed?

Answer 23

Total assets minus current liabilities

Question 24

What does the ROCE tell you?

Answer 24

How much money is made by the business compared to how much money has been put into the business

Question 25

What is a good ROCE?

Answer 25

Higher the better

Question 26

How can ROCE be improved?

Answer 26

By paying off debt to reduce non-current liabilities

Question 27

What do efficiency ratios show managers and shareholders?

Answer 27

How well the business is using its resources

Question 28

What does high gearing mean? In detail

Answer 28

High level of debt (long-term) vs equity on its capital employed

Question 29

How can a company benefit from high gearing?

Answer 29

In periods of low interest rates

Question 30

What does low gearing mean for interest payments on loans?

Answer 30

Limits it so if rates are high, this maximises profit

Question 31

What does inventory held for depend on?

Answer 31

On the industry

Question 32

What does inventory turnover mean?

Answer 32

Shows how many times a company has sold or replaced inventory in a given period

Question 33

What do some businesses do for high inventory turnover?

Answer 33

JIT

Question 34

What are receiveable days?

Answer 34

Average length of time taken by customers to pay amounts owed

Question 35

Why is it best to have low receiveable days?

Answer 35

Helps cash flow and working capital

Question 36

What can you compare receiveable days ratios with?

Answer 36

Previous months or years to look for trends

Question 37

What does aged receiveables analysis let managers do?

Answer 37

Control receiveables days

Question 38

What does gearing show potential investors?

Answer 38

Where a business's finance has come from

Question 39

What is a high gearing?

Answer 39

Over 50%

Question 40

How does gearing show how vulnerable a business is to changes in interest rates?

Answer 40

The more the business is borrowing, harder they will be hit by interest rates

Question 41

What does a high gearing tell you? 2 points

Answer 41

More than half of the business's finance comes from long-term debt Willing to take risks

Question 42

What does a low gearing tell you? 2 points

Answer 42

Most long-term funds come from shareholders and not borrowing Risk averse

Question 43

What are 2 rewards of being a high-geared business?

Answer 43

Extra funds for expansion When interest rates are low, high gearing is less risky

Question 44

What are 2 risks of being a high-geared business?

Answer 44

Might not be able to afford the repayments Can be risky due to interest rates

Question 45

What is the reward for shareholders if you have a high gearing?

Answer 45

Shareholders may expect higher dividends and a big increase in share price - could sell shares for profit

Question 46

What is the risk for shareholders if you have a high gearing?

Answer 46

Business may fail if can't keep up with repayments and shareholders can lose all money they have invested.

Question 47

Why are ratios a good way at looking at performance over-time?

Answer 47

Used to spot trends and strengths and weaknesses

Question 48

What are 2 disadvantages with financial ratios?

Answer 48

External factors aren't reflected Only contain info about past and present

Question 49

What are payables days?

Answer 49

Average length of time taken by a business to pay amounts it owes

Question 50

What can a high figure of payables suggest?

Answer 50

Liquidity problems

Question 51

Is it better to have a higher or lower figure for payable days?

Answer 51

Higher figure is Better because the longer it takes means that there is cash in the bank which is good for cash flow.