P1 Ratios Flashcards

1
Q

Uses of ratio analysis

A
  • To review the performance of an organisation over time
  • Compare the performance of organisation with specific competitors
  • Compare performance with published industry averages
  • Use analysis of past performance to help forecast future performance
  • Highlight problems in a company
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2
Q

Profitability ratios

A

Indicator company’s efficiency at generated profits or revenue from available resources

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3
Q

Liquidity ratios

A

Indicate company’s ability to pay for its liabilities

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4
Q

Management/ activity ratios

A

Provide information about efficiency of management at controlling the business

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5
Q

Capital risk ratios

A

Provide information about exposure to risk

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6
Q

Return on capital employed ROCE (primary ratio)

A

(PBIT / Capital employed) x 100

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7
Q

PBIT also known as

A

Operating profit

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8
Q

Problem with ROCE

A

Particularly sensitive to valuation of non current assets

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9
Q

Return on capital employed ROCE measures

A

The return generated by organisation from available capital > how efficient organisation is at generated profits from its capital

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10
Q

Return on equity (ROE) measures

A

Profits made by organisation for the shareholders

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11
Q

Return on equity =

A

(Profit available for ordinary shareholders / Total equity) x 100

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12
Q

Net profit margin =

A

(PBIT / Revenue) x 100

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13
Q

Net profit margin considers

A

PBIT as a percentage of revenue

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14
Q

Asset turnover =

A

Revenue / capital employed

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15
Q

Asset turnover shows

A

Useful information about efficiency of company at generating revenue from its capital

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16
Q

ROCE =

A

Net profit margin x asset turnover

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17
Q

If ROCE moves from one year to the next

A

Should calculate net profit margin and asset turnover to provide more info

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18
Q

Gross profit margin =

A

Gross profit / revenue x 100

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19
Q

Gross profit margin measures

A

Ability of the business to sell goods for more than they cost to make

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20
Q

Current ratio =

A

Current assets / current liabilities

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21
Q

Current ratio assesses

A

Organisation’s ability to meet its short term debts

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22
Q

Quick ratio =

A

(Current assets - inventory) / current liabilities

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23
Q

Quick ratio is

A

Harsher test of liquidity

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24
Q

Days trade receivables

A

(Trade receivables / credit sales) x 365

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25
Q

Days trade receivables shows

A

Approx number of days credit customers are taking to pay their debts

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26
Q

VAT treatment of days trade receivables

A

Must either strip out VAT from receivables ( x 5/6) or gross up sales to include VAT (x 1.2)

27
Q

Days trade payables

A

(Trade payables / Credit purchases and overheads) x 365

28
Q

Days trade payables shows

A

The number of days’ credit the business is taking from its suppliers

29
Q

Purchases

A

COS - opening stock + closing stock

30
Q

Inventory days

A

(Inventory / Cost of sales) x 365

31
Q

Inventory days measures

A

How many day’s inventory the company holds on average

32
Q

Cash operating cycle =

A

Inventory days + days trade receivable - days trade payables

33
Q

Inventory turnover =

A

Cost of sales / inventory

34
Q

Inventory turnover shows

A

Number of times inventory was sold during the year

35
Q

Gearing

A

(Long term debt + preference shares) / x 100

total equity OR capital employed

36
Q

Gearing ratio shows

A

What proportion of assets of the company have been financed by lenders rather than shareholders

37
Q

If redeemable, preferences shares should be

A

Classified as debt

38
Q

Debt ratio =

A

(Total debt / total assets) x 100

39
Q

Interest cover =

A

PBIT / Interest Charges

40
Q

Interest cover ratio shows

A

The number of times that the company can afford to pay its interest charges

41
Q

Earnings per share (EPS) =

A

Profit attributable to ordinary shareholders / Number of ordinary shares in issue

42
Q

Price earnings (PE) ratio =

A

Share price / earnings per share

43
Q

PE ratio shows

A

Value of the share price as a multiple of the earnings per share > shows how many times the earnings per share an investor is prepared to pay to buy a company share

44
Q

Earnings yield =

A

Earnings per share / Share price OR 1 / PE

45
Q

Dividend cover =

A

Profits available for distribution to ordinary shareholders / Dividends paid

46
Q

Dividend cover shows

A

Measure of how many times the dividend actually paid divides into the profits that could have been paid out as a dividend by the company

47
Q

Dividend yield =

A

(Dividend per share / share price) x 100

48
Q

Dividend yield measures

A

Annual return received in dividends as a percentage of current share price

49
Q

Debt provider ratios

A
  • Asset cover > assets of the business provide security for debt, should be > 1
  • Cash flow cover > review cash flow forecasts to ensure capital and interest repayments can be repaid comfortably
50
Q

Limitations of ratio analysis - four key categories

A
  • Timing
  • General
  • Comparisons between companies
  • Other sources of information
51
Q

Timing limitations of ratio analysis (4)

A
  • Seasonal variations may be missed
  • Can adjust payment patterns towards YE to manipulate ratios
  • If new accounting standards introduced, like for like comparison is hard
  • Inflationary effects may be missed
52
Q

General limitations of ratio analysis (4)

A
  • Only guidelines
  • Assumptions and estimates made are subjective
  • Difficult to access sufficient information
  • Difficult to produce meaningful analysis on consolidated financial statements across a number of industries
53
Q

Comparisons between companies > limitations of ratio analysis (3)

A
  • Companies and policies must be comparable
  • Allow for differing accounting policies
  • Cost classification should be considered
54
Q

Ratios should be considered alongside

A

Other sources of information eg chairman’s statement, auditor’s report, publicity

55
Q

Financial distress

A

Occurs when a company is unable to pay its debts as they fall due. If a solution is not found, will lead to insolvency

56
Q

Z score

A

Designed to overcome some of basic difficulties with accounting ratios - form of multivariate analysis and considers a number of ratios simultaneously

57
Q

Z score > 3

A

Sign of health

58
Q

Z score < 1.8

A

Could mean the company is heading for insolvency

59
Q

Limitations of Z score model (4)

A
  • Different companies classify items differently
  • Lack of specified time frame
  • Model is not scientifically proven
  • Calculated upon historic data
60
Q

A score

A

List of questions grouped into defects, mistakes and symptoms of failure with associated scores

61
Q

A score > 25

A

Could be heading for failure

62
Q

Symptoms of overtrading (4)

A
  • Rapid increase in sales revenue
  • Rapid increase in volume of current assets
  • Only small increase in equity capital
  • Dramatic movement in debt and liquidity ratios
63
Q

Reducing overtrading (3)

A
  • Injecting new capital from shareholders
  • Improving working capital management through better control of inventories and trade receivables
  • Abandon ambitious plans and focus on consolidating position
64
Q

Causes of overtrading (3)

A
  • Seeking to increase revenue too rapidly without adequate capital
  • Repayment of loan without replacement
  • In a period of inflation, retained profits may be insufficient