interpretation

Question 1

What are the profitability ratios?

Answer 1

ROCE
GPM
Expenses as % of sales

Question 2

What are the liquidity ratios?

Answer 2

Current
Quick

Question 3

What are the efficiency ratios?

Answer 3

Asset turnover
Inventory turnover
Receivables

Question 4

What are the investor-specific ratios?

Answer 4

RoE
Earnings per share
PE ratio
Dividend yield
Dividend cover

Question 5

What’s the relationship in ROCE?

Answer 5

Net Profit Margin x Asset turnover

Question 6

What is ROCE?

Answer 6

• Measures returns back to a business
• Operating profit (before interest) compared to non-current liablities and total equity
• Rewards investors for risk they are taking
• Higher = better
• Changes due to return on sales or asset turnover or both

Question 7

What is the current ratio?

Answer 7

• Compares liabilities due within the year and assets that will turn into cash during the year
• Should be 2:1 but depending on sectors lower can be fine
• Sometimes too high means they are too liquid (cash doesn’t make interest etc) / Not making the most out of short term finance

Question 8

What is the acid test?

Answer 8

• ability to pay its short-term obligations using only its most liquid assets
• Recognises inventory sometimes takes time to convert into cash
• 1:1 usually good
• Considered against operating cash flow

Question 9

What is asset turnover?

Answer 9

• Ability of organisation to generate sales
• Generally higher better but can also over-trade
• High asset turnover usually means low return on sales
• Retailers have high asset turnover

Question 10

What is receivable days?

Answer 10

• How fast money is collected from debtors - faster the better
• Too long may mean bad debts - but too much pressure may damage business rapport

Question 11

What is inventory days?

Answer 11

• Measures how long a company keeps stock before it is sold
• Shorter the better
• Too little may mean there are production stoppages and dissatisfied customers

Question 12

What is payable days?

Answer 12

• Measures average amount of time taken to pay suppliers
• Long is good for customers liquidity but bad for relationships with suppliers

Question 13

What is gearing?

Answer 13

• The ability to meet long term debts
• Capital gearing and interest cover

Question 14

What is capital gearing?

Answer 14

• Proportions of owner’s capital and borrowed capital to fund business
• Large borrowed capital is risky as repayments are legal requirements and need to be met to avoid insolvency
• Borrowed capital is attractive to companies as lenders accept a lower rate of return than equity investors due to their secured positions

Question 15

What is interest cover?

Answer 15

• Income gearing
• How many times a company’s operating profit exceeds interest payable
• Higher the figure the more safe a company is and over 4 is good

Question 16

How to analyse 1 company over 2 periods?

Answer 16

• Consider one-off events (strip these out and recalculate ratios)
• Consider impacts of new products, new customers or changes in the market

Question 17

How to analyse 2 entities in same period?

Answer 17

• Differences in accounting policies
• If acquisition: Liquidity of companies and synergies

Question 18

Comparisons of an entity with sector averages?

Answer 18

• Entities in same sector will have different margins
• Firms may have different year ends
• Different accounting policies

Question 19

What are some random tips?

Answer 19

• Calculate the percentage changes
• Tell the story using the parts from the given text