Interpreting Financial Statements 1 Flashcards
what does it mean to interpret a financial statement
evaluate financial information and make judgement about issues such as profitability, efficiency, liquidity, gearing, cashflow
what are the different users of the financial statement
shareholders, debt providers, customers, suppliers, competitors, governments
what different questions are being asked of the financial statement
will they go bankrupt, where will they be in a number of years time, is it a good investment/loan, how does the company benefit society
what does CORE analysis stand for
context, overview, ratios, evaluation
why do we use ratios
ratios help with comparisons between different sized businesses
they give a relative measure
what might profit be compared to to assess performance
size of business, capital investment, revenue
how might we interpret a result as being good or bad
comparing creates meaning
compare with same ratio from the past, the budgeted or planned ratio, similar businesses, industry averages
what five categories of ratio might be considered the most meaningful
profitability, efficiency, liquidity, financial structure, investment
what does a profitability ratio tell us
what return is being made from capital and assets
what profit to use
what does an efficiency ratio tell us
is the business making efficient use of resources
what does a liquidity ratio tell us
is there enough short term cash and can current obligations be met
what does a financial structure ratio tell us
is the company financed by debt or equity and how risky is the financing
what does an investment ratio tell us
what return is available to the shareholders and what is the investor confidence
operating profit
profit before interest and tax (PbIT)
capital employed (equation)
non-current assets + current assets - current liabilities = share capital + reserves + non current liabilities
name the four profitability ratios
return on capital employed (RoCE), operating profit margin, asset turnover, gross profit margin
what is the return on capital employed ratio
(PbIT/share capital + reserves + long term loans) x 100%
what is the operating profit margin ratio
(PbIT/revenue) x 100%
what is the asset turnover ratio
revenue/(share capital + reserves + long term loans) times (x 100% usually omitted)
what is the gross profit margin ratio
gross profit/revenue x 100%
what is the meaning of the gross profit margin
expressing the gross profit as a percentage of revenue
for every £1 of revenue how much was remaining as gross profit
how well have you controlled cost of sales
what is the meaning of the return on capital employed
the profit before interest and tax as a percentage of capital employed
why is PbIT used
it is the profit earned to pay providers of finance
it is the profit which the managers have the most control over
what is the meaning of the operating profit margin
operating profit as a percentage of revenue
for every £1 of revenue how much was operating profit
what is the meaning of the asset turnover ratio
really an efficiency ratio
revenue as a percentage of capital employed
how many times was revenue turned over in assets
what is another way to think of the return on capital employed
operating profit margin x asset turnover
what would an increase in return on capital employed be the result of
increase in operating profit margin and increase in asset turnover
what problems are associated with the return on capital employed ratio
the method of calculation can vary, what is considered capital employed, which profits to use
are the assets being valued at current prices
capital investment often results in low returns in the early years so long term projects can distort short term RoCE
what would be the effect of a lower net book value
higher RoCE
what would happen if the assets are undervalued
the RoCE may be misleadingly high
name the three efficiency ratios
inventory turnover, receivables collection, payables payment
what is the inventory turnover ratio
inventory/cost of sales (per day) (days)
what is the receivables collection ratio
trade receivables/credit sales (per day) (days)
what is the payables payment ratio
trade payables/cost of sales (per day) (days)
how do the three efficiency ratios relate to the working capital cycle
WCC = inventory + receivables - payables (days)
what is the meaning of the inventory turnover period ratio
measuring the efficiency of stock
it is the average number of days that inventory is held
based only on the year end balance sheet data
in general do you prefer a higher or lower inventory turnover
lower
what is the meaning of the receivables collection (debtors) ratio
efficiency of debtors
how long credit customers take to pay their bills (on average)
could be distorted by one slow paying customer with large credit
what is the meaning of the payables payment ratio
efficiency of creditors
how long it takes to pay suppliers (on average)
can be distorted by slow payment to one large supplier
what is the meaning of the working capital cycle
measure of the difference between payments made to suppliers and cash received from customers
should be as short as possible to reduce the amount of short term capital required to operate
why might inventory days have decreased
efficient control and faster selling
why might receivables days have increased
customers are paying slower, may be deliberate to increase revenue
why might payables days increase
short of cash, could harm supplier relationships
name the two liquidity ratios
current ratio and acid-test ratio
what is the current ratio
current assets/current liabilities (times)
what is the acid test (quick) ratio
(current assets - inventory)/current liabilities (times)
what is liquidity
the ability to meet short term obligations when they are due
is there an ideal size for the current ratio
generally the higher the current ratio, the more liquid it is
cause for concern might be a decreasing current ratio
if CA<CL the company can pay short term bills but not good if too large
what is the meaning of the acid test ratio
more stringent assessment of the liquidity because inventory is the least liquid asset
can current liabilities be covered without having to sell inventories
<1 have to sell inventories to meet current liabilities
why might the WC balances not be representative of the liquidity during the year
unexpected events, seasonal business, management manipulation
