Lesson 14 - Evaluating Performance Flashcards
Define liquidity.
The ability of the business to meet short term debts as they fall due.
Define stability.
The ability to meet debts and continue operation in the long term.
Define profitability.
The ability of a business to generate a profit compared against a base of sales, assets or owner’s equity.
What is the WCR formula?
T/f - WCR measures liquidity.
True - Working Capital Ratio is a liquidity indicator that measures the ratio of current liabilities to current assets to assess the firm’s ability to meet its short term debts.
Complete the answer…
For every $1 of Current Liabilities, this business has $0.37 of Current Assets, which is an indication that it is likely to have trouble meeting it’s short-term debts as they fall due because …
…the business has fewer current assets that can be converted to cash or used to generate cash than it has in current liabilities.
What is the debt ratio formula?
T/f - Debt Ratio measures the stability of a business.
True - debt ratio measures the proportion of the firm’s assets that are funded by external sources of finance. It is a measure on the stability of a business. It is expressed as a percentage.
Complete the answer…
A relatively low debt ratio is good for the stability of the business because …
…the business should easily be able to make repayments on its debt and continue operations into the long term due to the low level of risk.
Complete the answer…
However, a low debt ratio could be problematic as…
…this could be a sign of a missed opportunity for business as they could take on more debt to fund further expansion of the business leading to a larger market share and a higher profit for the owners.
What is the ROA formula?
Return on assets is a profitability ratio that provides how much profit a company can generate from its assets. In other words, return on assets (ROA) measures how efficient a company’s management is in earning a profit from their economic resources or assets on their balance sheet.
Give two ways a business could improve its ROA.
**Strategies could include: **
1. Renegotiate with existing supplier to secure a cheaper price for supplies/materials
2. Change suppliers to access a cheaper price for supplies/materials
3. Buy materials in bulk in order to access a discount making materials
4. Review staff rostering in order to minimise wage expense
5. Effective marketing / advertising that will boost sales by a greater amount that the amount spent on marketing / advertising.
6. Improve service delivery in order to build positive word of mouth in the market = boost to sales
How could we improve ROA if net profit was to remain steady?
Reduce average total assets:
* Sell unproductive / idle / obsolete assets.
* Sell assets, and then lease back
Complete the answer…
A ROA of 2.37% indicates that the business does not use its assets efficiently to generate a profit, a strategy they could use to improve this is …
…to boost sales through the use of effective marketing. This would increase the business ROA by increasing the level of profit relative to the assets used by the business as sales revenue is increased at a faster rate than expenses.
Another option would be to sell idle assets and this will improve the ROA by reducing the average total assets in the business without getting rid of assets that contribute to the generation of revenue.
