lec 7 - ratios Flashcards
what do financial ratios provide/ are useful fo r
meaningful comparison between entities e,g which is more profitable
can compare finacnail psoition of firm over time
what are the 3 things ratios can measure
profitability
liquidity
solvency
ROCE
PBIT/NET CAPITAL EMPLOYED
How do we calculate net capital employed
equity + NCL
Total assets - current liabilties
what does ROCE shjow us
for every £1 of capital employed how much profit company generates
efficiency of comp in utilising capital to generate profit
the higher the ROCE the
better
gross profit margin
gross profit (rev-csot of sales)
/
revenue
x 100
whats bad about gross profit amrgin
doesnt take into account any other costs but the costs of production
differnce between margin and and mark up
mark up - profit is measured as a % of costs
margin - profit is measured as a % of revenue
gross profit mark up
gross profit
/
cost of sales / TC(dEPENDS ON COMPANY POLICY)
- 100
OPERATING profit margin
operating profit/
revenue
x100
how do we work out operating profit
gross profit - (selling and distribution costs + aadmin costs)
what does operating profit margin show
how much operating profit earned for every £1 of sales
we can compare gross profit marign to operating profit margin to see
how much revenue is lost to expenses
net profit maegin
net profit/revenue x 100
net profit margin shows
% of sales that is neet profit
net profit
Operating profit - finance - tax
how can we compare the net profit to the operating profit - as in what does the commparison show us
how much rev is lost to expenses including interst
if we need to calcaulte ROCE but no finance costs (as dont ake out debt ) and they say ignore tax waht profit figure do we use
net profit
liquidity
ability to generate cash and satisfy st liablities - without which business willl fail
company has a what to satisfy ST Liabilities
obligation
working capital equation
CA - CL
CA - CL why is this relevant to liquidity
copmany can only really use CA to pay em off
as fast for company to convert CA into Cash
Current Ratio
CA/CL
What does current ratio show us
extent to which CL are covered by CA
Why dont we want the current ratio too high
indicate company not spenidn gmoney properly and it being too conservative
conventionally what do we want our CA to be i.e the satisfactory level
2:1
acid test ratio
current assets - inventory/ current liabilities
in acid test ratio why do we takeaway teh inventories
aren’t as liquid as other current assets
hard for firm to turn all of inventory into cash
why is it hard for the firm to turn inventory into cash
firm dont decide whether or not they can sell its the mkt demand that determines this
if sel stock all now got to
heavily discount - so wont get the full value
measures of working capital manangemnt
payables days
recievables days
inventory days
recievables days
how long takes to recieve payment from creditors
payables days
how long it takes to pay credit suppliers
what is inventory days
how long stock is held before it is sold
the faster which days the better
recievbles
what do we want to be higher in than the other ttype in term - P or R
P as we wannt more time to pay it off
why is a high payables day good
interest free credit
why do wwe want a high payables day but not too much as
want high - retain cash and I elsewehere rather than payback interst free borrowing
not oo much
affect company credit - mroe problems in the future
supplier might stop supplying
suggest dinancial weakness
receivables days
receivables/revenue x 365 RR 365
we want recievables back quick but waht is the good thing id company extends credit period
increase revenue as more people will be open
payables dyas
PAYABLES /PURCHASES x 365
inventory days
inventory/cost of sales x 365
measures of solvency
gearing ratio
leverage ratio
what is solvency
ability to service and repay long term liablities
i.e make interest payments and pay off full amount
what are the two main sources of financing opration/projoects
equity
debt
equity is
issuing share and sellinghtem to stkh
debt is
corporate bonds , bank loans etc
why is equity less riskier than debt
debt - got financial obligatio ot make paymentsd
where as with equity no obligation to make a return or payback sh
repaymnet i s abig burden
what do teh solvency ratios tell us
% of debt company has
leverage/ debt to qeuity ratio
long term debt/equity x 100
the leverage ratio is relative to
equity
the gearing ratio is relative to
the whole source of finance
gearing ratio
long term debt/long term debt + equity x 100
if company got 20% equity how much debt do they have
80%
the higher the debt
the higher the risk of solvency
if you invest in a highly geared company in a good econ environwmnt what is likel
get lots of money back and vise versa
if we wanna check if a firm can afford its deb s what do we check
interest cover ratoi
what is the interest cover ratio
indicates companies ablity to service it’s borrowing
interest cover ratio formula
profit before interest /interest expense
how can a modification of interest cover be obtained
replacing earnings with cash flows from operations
profit before interest aka
operating profit
