Financial Ratios

Question 1

What are non-current assets?

Answer 1

• Value of the assets that the business has purchased and expects to keep in the business for more than one year.

Question 2

What are current assets?

Answer 2

• The assets a business owns which are either cash, cash equivalents, or are expected to be turned into cash during the next twelve months.

Examples include:

• Cash balances
• Trade debtors (receivables)
• Stock

Question 3

What are current liabilities?

Answer 3

• Amounts owed by the business that need to be paid within the next 12 months.

Question 4

What are non-current liabilities?

Answer 4

Liabilities that are not due to be paid in the next 12 months but still need to be reflected in the balance sheet.

Question 5

What is ratio analysis?

Answer 5

• The comparison of financial data to gain insights into business performance.

Question 6

Who are the key users of profitability ratios? Give at least two examples.

Answer 6

At least two from:

• Shareholders
• Government
• Competitors
• Employees

Question 7

Who are the key users of liquidity ratios?

Answer 7

• Lenders
• Suppliers
• Shareholders

Question 8

Who are they key users of financial efficiency ratios?

Answer 8

• Shareholders
• Lenders
• Competitors

Question 9

What do profitability ratios do?

Answer 9

• Assess the returns earned by a business from its trading activities and investments.

Question 10

What does return on capital employed (ROCE) measure?

Answer 10

• Whether or not the business is making a satisfactory level of profit.

Question 11

With regards to the ROCE percentage, what percentage is better?

Answer 11

• The higher the percentage the better.

Question 12

With regards to operating profit, what percentage is better?

Answer 12

• The higher the percentage the better.

Question 13

With regards to gross profit, what percentage is better?

Answer 13

• The higher the percentage the better.

Question 14

What is the equation for current ratio?

Answer 14

Current assets/current liabilities

Question 15

What is the purpose of the current ratio?

Answer 15

• To see if the business has enough liquidity - ability to pay its debts - in the short term (within a year).

Question 16

What is the purpose of the acid test?

Answer 16

• To see if the business has enough liquidity to pay its debts in the short term. WITHOUT INCLUDING STOCK.

Question 17

What is an ideal current ratio figure?

Answer 17

Above 1 - this means that the business has more current assets than it does current liabilities.

Question 18

What is an ideal acid test ratio?

Answer 18

Above 1 - this means that the business has more current assets than it does current liabilities.

Question 19

What is the purpose of gearing?

Answer 19

To see how reliant the business is on loans.

Question 20

With regards to gearing, what percentage is best?

Answer 20

The lower the percentage, the better.

Question 21

What is payables days?

Answer 21

How much time it takes the business to pay its debts.

Question 22

What is receivables days, and should it be smaller or bigger than payables days?

Answer 22

How much time it takes the business to be paid by customers.

Smaller than payables days

Question 23

What does inventory turnover refer to?

Answer 23

How many times a year a business is able to sell its stock.

Question 24

Complete the sentence

The h__________ the inventory turnover, the ______ the business is at managing its stock.

Answer 24

• Higher

- Better

Question 25

In what ways is ROCE useful? | Give at least one example.

Answer 25

At least one from: - Useful to evaluate overall business performance. - Useful to provide a target for individual projects. - Useful to provide a benchmark against competitors.

Question 26

How is return on capital employed calculated?

Answer 26

OPERATING PROFIT / TOTAL EQUITY + NON CURRENT LIABILITIES X100

Question 27

How can ROCE be evaluated? | Give at least two examples.

Answer 27

At least two from: - It is relatively easy to calculate and compare information between businesses and their competitors. - Percentage figures will differ between industries. - The data used is only a snapshot of business performance at a particular time.

Question 28

How can current ratio be evaluated? | Give at least two examples.

Answer 28

At least two from: - A ratio of above one means that the business has more current assets than it does current liabilities - efficient management of of working capital. - A low ratio (well below 1) could suggest potential liquidity problems. - Really high ratio could suggest that the business has too much working capital tied up in stock.

Question 29

What is the acid test ratio formula?

Answer 29

Current assets (excluding inventories) / Current liabilities

Question 30

How can the acid test ratio be evaluated?

Answer 30

- Less relevant for businesses with high stock turnover.

Question 31

How is inventory turnover calculated?

Answer 31

Cost of goods sold / average inventories held

Question 32

What might a fall in inventory turnover suggest?

Answer 32

- A build up of slow moving stocks.

Question 33

Give at least three examples of the limitations of ratio analysis.

Answer 33

At least three from: - one set of data is not enough. - financial data used is from the past. - the information might not be entirely reliable because it is possible for financial data to be manipulated.

Question 34

Why might it be okay to have high gearing at the moment?

Answer 34

- Low interest rates mean that borrowing is cheap, meaning that it could potentially be the best option for it.

Question 35

How is gearing calculated?

Answer 35

Long term liabilities / capital employed

Question 36

What is the downside of selling shares to raise money?

Answer 36

- More profit is being given away to the shareholders through a dividend.