Module 10 Working Capital Management and Ratios

Question 1

Financial ratios usually fall into four categories, which are:

Answer 1

• Profitabilty
• Liquidity
• Activity
• Risk

Question 2

What is Gross Margin?

Answer 2

Measures gross profit as a percentage of sales

Gross Margin % = Gross Profit / Revenue

Question 3

What is Mark up Ratio?

Answer 3

Similar to gross marking but this one expresses gross profit as a percentage of cost of sales rather than a percentage of revenue.

Mark up % = Gross Profit / Cost Of Sales

Question 4

For working out Net Profit Margin, what do you need to remember to add to profit before tax?

Answer 4

Any interest payables

Question 5

What is Capital Employed?

And what is not included as part of the capital

Answer 5

Refers to the funds provided by both shareholders and non-current lenders

Trade payables are not included

= Total Assets - Current Liabilities

or

= Equity + non current Liabilities

Question 6

What does Asset Turnover x Net profit Margin =

Answer 6

ROCE (return on capital employed)

Question 7

What is Earnings per share (EPS) and how is it calculated?

Answer 7

EPS = (Profit attributable to ordinary shareholders) / (Number of shares)

Profit attributable to ordinary shareholders = Profit - Tax - Preference Dividends

Question 8

What is the purpose of liquidity ratios?

Answer 8

Are designed to provide information regarding the company’s ability to pay for its liabilities

Question 9

What are the two ratios used to measure a companies liquidity?

Answer 9

1) Current Ratio

2) Quick Ratio (also known as an acid test)

Question 10

Why is Quick ratio useful in industries such as heavy engineering?

Answer 10

This ratio excludes inventories. Industries such as engineering have less ability to sell inventories to cash in short notice

Question 11

What is a companies ‘Gearing Ratio’?

Answer 11

The relationship between the non-current debt provided by lenders and the equity funds provided by shareholders

Question 12

What is the level of debt acceptable in the UK?

Answer 12

50%

Question 12

What does interest cover mean?

Answer 12

This ratio approximates the number of times that a company can afford to pay its interest charges

Question 13

What interest cover value indicates a company can no longer meet interest expense?

Answer 13

1

When a company’s interest coverage ratio gets to one, the company can no longer meet its interest expense obligations and will likely cease to trade in the immediate future.

The LOWER the number the RISKIER the position of the company

Question 14

What are management ratios intended for?

Answer 14

Designed to provide information about the speed of cash flowing into or out of the organisation

Question 15

What does days trade receivables show?

Answer 15

Measures the effectiveness of the business in collecting its debts

Question 15

What does days trade payeables show?

Answer 15

approximation of the number of days of credit the business is taking from its suppliers.

Question 16

What does inventory turnover show?

Answer 16

Calculates an approximation of the number of times the current level of inventory was sold during the year

Question 17

What is inventory days the reverse of?

Answer 17

Inventory turn over calculation

Question 18

What is the working capital cycle?

Answer 18

The length of the working capital cycle is the amount of time taken from cash leaving the business to pay for inventories until a cash inflow is received

Question 19

What are some limitations of ratio analysis?

Answer 19

• Ratios can be calculated using info that is historic
• Different orgs may have different accounting principles. This need to be taken into account when comparing to other orgs
• Can be difficult to access sufficient information
• When comparing ratios the companies must be comparable

Question 20

What are the limitations of the EOQ model?

Answer 20

• It assumes that materials are used at a constant rate
• It has limited use in dealing with materials whose use cannot be predicted
• It has limited use in dealing with materials whose prices fluctuate radically
• It depends upon historical data, which may not be an accurate guide to the future

Question 21

The optimal order quantity to minimise the total inventory cost is:

Answer 21

• The pre discount EOQ level
  or
• The minimum order size necessary to earn the discount