Financial Ratio Analyses 3.7.2 Flashcards
What is return on capital employed
It is profitability ratio
It tells us what returns (profits) the business has made on the resources available to it.
formula: operating profit/capital employed x100
The capital employed figure normally comprises:
Share capital + Retained Earnings + Long-term borrowings
what is the current ratio
It is a liquidity ratio
Whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due.
Liquidity ratios focus on the short-term and make use of the current assets and current liabilities shown in the balance sheet.
The current ratio is a simple measure that estimates whether the business can pay debts due within one year out of the current assets. A ratio of less than one is often a cause for concern, particularly if it persists for any length of time.
current ratio = current assets/current liabilities
what is the gearing ratio
Measures the proportion of assets invested in a business that are financed by long-term borrowing.
In theory, the higher the level of borrowing (gearing) the higher are the risks to a business, since the payment of interest and repayment of debts are not “optional” in the same way as dividends.
Long-term liabilities include loans due more than one year + preference shares + mortgages
Capital employed = Share capital + retained earnings + long-term liabilities
Gearing ratio= longterm liabilities/capital employed x100
Name some efficiency ratios
payable days
receivable days
inventory turnover
the value of financial ratios when measuring performance
Useful in Financial Position Analysis
Useful in Assessing the Operational Efficiency
Useful in Forecasting Purposes
Useful in Locating the Weak Spots of the Business
It helps in comparing companies
what are payable days
The Creditor (or payables) days number is a similar ratio to debtor days and it gives an insight into whether a business is taking full advantage of trade credit available to it.
Creditor days estimates the average time it takes a business to settle its debts with trade suppliers. The ratio is a useful indicator when it comes to assessing the liquidity position of a business.
In general a business that wants to maximise its cash flow should take as long as possible to pay its bills.
what are receivable days
The debtor (or trade receivables) days ratio is all about liquidity.
The ration focuses on the time it takes for trade debtors to settle their bills. The ratio indicates whether debtors are being allowed excessive credit.
A high figure (more than the industry average) may suggest general problems with debt collection or the financial position of major customers. The efficient and timely collection of customer debts is a vital part of cash flow management, so this is a ratio which is very closely watched in many businesses.
what is inventory turnover and what does it mean if a business has a large inventory turnover
Stock turnover is a financial efficiency ratio that helps answer a questions like “have we got too much money tied up in inventory”?
formula: cost of sales/average cost of stock help
a large inventory can be very good for a business as it shows that it is replacing it stock a lot which means it is getting a lot of sales. it can also though represent poor stock control as it isn’t holding enough stock as each time to meet demand which meas that a low inventory turnover isn’t always a ad thing as you could be stocking up to meet large demands
ways to improve inventory turnover
A business can take a range of actions to improve its stock turnover:
Sell-off or dispose of slow-moving or obsolete stocks
Introduce lean production techniques to reduce stock holdings
Rationalise the product range made or sold to reduce stock-holding requirements
limitations of financial ratios
They usually use averages to calculate their ratios which can be misleading as it doesn’t show trends over the time you averaged and can cause results to be inaccurate
If some of the information used in the calculations are estimated then it can be biased
