Financial ratios Flashcards
Current ratio
Current assets / Current liabilities= ….times
Explanation of current ratio
It gives an indication of liquidity by showing how many
times the current liabilities are covered by the current assets
Quick ratio
Current assets - inventory / current liabilities= ….times
Explanation of quick
ratio
A better test of immediate liquidity,
It removes inventory which can take time to sell and corvert into cash
Trade receivables payment period
(Receivables/ Credit sales)x 365= …..days
Trade receivables payment period
(Receivables / Revenue ) x 365= …… days
Explanation of trade receivables payment period = ….days
Shows the average number of days receivables pay take to pay
Show how quickly we can get the money from our customers
Trade payables payment period
(Payables / credit purchases ) x 365= …..days
Trade payables period payment
(Payables/ COGS ) x 365= …..days
Explanation of trade
payables payment period
Shows the average days the business takes to pay their
credit suppliers
Explanation of working capital cycle
It measures how long a business needs to fund its purchases of goods
the longer cycle, the longer the business has to find
financing
How to reduce the working capital cycle?
The company needs to reduce the amount of time items are kept in stock, reduce the theme it takes to collect debts from customers and
increase the time it takes to pay its suppliers
Inventory holding period
(Inventory / COGS ) x365 = …… days
Explanation of inventory holding period
Shows the average number of days inventory is
held before it is sold
Operating profit margin
(Profit from operations/ Revenue) x 100 = ….. %
Explanation of operating profit margin
It shows in our sales what profit we have got remaining after
we paid our operating costs
Falling margin may be due to increased costs of sales, sales
prices being reduced to increase market share
Interest cover
Profit from operations / Interest charges= …..times
Explanation of interest cover
Measures how easily the business can make its
interest payments out of profit
Gearing ratio
Total debt/ total debt + total equity x 100 =….. %
Explanation of gearing ratio
Measures the financial risk of the company, when assessing the
coldit status of a customer the credit controller will be concerned with their long-term stability
What does high gearing mean in the business?
There will be less cash available in the business as the cash balance will have been reduced by high interest payments
Lenders are less likely to want to lend the company more money
so we should be cautious when granting credit
Return on capital employed
Profit from operations (net profit) / Capital employed x100 = ….. %
Profit from operations / TALC
TALC = total assets less current liabilities
TALC= total equity+ non - current liabilities
Explanation of return on capital employed
Measures how much profit is generated for every £ of assets employed
Indicates how efficiently the company uses its assets
Compares profits to the overall size of the business
Gross profit margin
Gross profit /Revenue x 100 = …… %
Explanation of gross profit margin
How profitable the trading activities of the business are
What causes the fall in the gross profit margin ?
Increased cost
Reduced volumes
Lower selling price
Current ratio - how we use them If a company can be granted credit
This ratio shows the amount of current assets in relation to the current liabilities and is a measure of the liquidity of the business. If the company has a ratio of 2:1 it means that for every £ 1.00 of current liabilities the company has £ 2.00 Of current assets. Therefore in theory the business is liquid
Making less gross profit from its sales which could
be….
Decrease in selling prices and/or an increase in the cost of sales
Interest cover
Interest Cover is a key indicator that is often used by credit agencies
and financial institutions to calculate how many times the operating profit can cover the interest payments
Interest paid is covered by the profit from operations by …. times
Current ratio
Higher current ratio indicates a better credit worthiness when assessing a potential credit customer
Current ratio is ….
A crude measure of solvency
Gross profit margin reduction - Why ?
The selling price has decreased or the cost of sales has increased
The current ratio has fallen because
1) Increase in current liabilities
2) Decrease in current assets
What has happened to the operating profit margin %?
The operating profit margin % has increased from 15.32% to 32.00%.
The percentage has more than doubled, which means the company is generating more profit which in turn should improve liquidity.
What has happened to the interest cover?
Interest cover has increased from 8.00 to 2.1 times.
The operating profit excellent cover for finance costs, which again indicates higher liquidity.
What has happened to the current ratio?
The current ratio has also increased from 1.03 to 2.00 times.
The current ratio is a direct indicator of liquidity. It gives an indication of liquidity by showing how many times the current liabilities are covered by the current assets.
What has happened to the gearing %?
Gearing has dropped from 65.22 to 46.67%.
The company is now less reliant on external financing - and the finance cost of covering that financing- which means that an increase in the credit limit lessens credit risk for the company.
What do the positive trends of all four performance indicators imply?
The trends of all four performance indicators are very positive and will greatly reduce the level of credit risk, meaning that a positive recommendation may be given to the Finance Director for the increase in credit limit from 50000 to 90000.00.
Performance indicators: Operating profit margin %, Interest cover, Current ratio, Gearing %
Current ratio - explanation
Current ratio : 0.38 in 2007
Current ratio: 0.35 in 2006
The current ratio has been consistent between the two
years, however, this may be considered low for this
type of business at around 35p or 38p of current assets
for every £ 1.00 of current liabilities
Interest cover - reason of decrease
Decrease in operating profit margins
Quick ratio
The business meets its current liabilities by its current assets without the need to
convert inventories to cash
Ebitda/ total debt
Operating profit + depreciation / total debt
