performance measurement and control Flashcards
Gross profit margin formula
gp/revenue x 100
operating profit margin formula
Operating profit/revenue x 100
why is a high operating profit margin desirable
A high operating profit margin is desirable. It indicates that either sales prices are high or that all costs are being kept well under control
what is Return on capital employed (ROCE)
It is the operating profit as a percentage of the capital
employed. The ROCE shows the operating profit that is generated from each $1 of assets employed.
how to calc ROCE 2 formulas
ROCE = Operating profit/Capital employed ×100
OR
ROCE = operating profit margin × asset turnover
what is capital employed
total assets less current liabilities or total equity plus long-term debt.
how to achieve a desirable ROCE 2
- Increasing operating profit, e.g. through an increase in sales price or through better control of
costs. - Reducing capital employed, e.g. through the repayment of long term debt
what is turnover
the amount of money taken by a business in a particular period.
how to calculate asset turnover
turnover/capital employed
what does a high asset turnover show
a high asset turnover ratio means a company is performing efficiently, as the ratio means they are generating more revenue per dollar of assets.
how to achieve a high asset turnover
- Increasing turnover, e.g. through the launch of new products or a successful advertising
campaign. - Reducing capital employed, e.g. through the repayment of long term debt
what is liquidity
Liquidity refers to the efficiency or ease with which an asset or security can be converted into ready cash without affecting its market price.
how to calculate current ratio
current assets/ current ratio
what does current ratio show
The ratio measures the company’s ability to meet its short term liabilities as they fall due.
A ratio in excess of 1 is desirable but the expected ratio varies between the type of industry but lewer means can’t pay debts
how to calculate acid test, quick ratio
current assets - inventory / current liabilities
how to calc inventory holding period
inventory/ cost of sales x 365
what does inventory holding period show
This indicates the average number of days that inventory items are held for.
what does an increase in holding period show
An increase in theinventory holding period could indicate that the company is having problems selling its products and could also indicate that there is an increased level of obsolete inventory. The company
should take steps to increase inventory turnover,
what does a decrease in holding period show
A decrease in the inventory holding period could be desirable as the company’s ability to turn
over inventory has improved and the company does not have excess cash tied up in inventory
how to calc receivables collection period
receivables/ credit sales. x 365
what does this show
This is the average period it takes for a company’s debtors to pay what they owe.
why is a low period good
A decrease in the receivables collection period may indicate that the companies has improved its management of receivables. However, a receivables collection period well below the industry average may make the company uncompetitive and profitability could be impacted as a result
how to reduce the collection period
- Credit checks on customers to ensure that they will pay on time
- Improved credit control, e.g. invoicing on time, chasing up bad debts
how to calc payables collection period
payables / credit purchases x 365
what does a payables collection period show
This is the average period it takes for a company to pay for its purchases. If credit purchases are not available, ‘purchases’ or ‘cost of sales’ should be used.
what does a decrease in collection period show
A decrease in the company’s payables period could indicate that the company’s ability to pay for its purchases on time is improving. However, the company should not pay for its purchases too early since supplier credit is a useful source of finance
what does an increase in collection period shows
An increase in the company’s payables period could indicate that the company is struggling to pay its debts as they fall due. However, it could simply indicate that the company is taking better advantage of any credit period offered to them
what does financial gearing show
A high level of gearing indicates that the company relies heavily on debt to finance its long term
needs.
This increases the level of risk for the business since interest and capital repayments must be made on debt, where as there is no obligation to make payments to equity
how to calculate financial gearing
debt/ equity x 100
or
debt / debt + equity. x 100
how to improve the ratio
The ratio could be improved by reducing the level of long term debt and raising long term
finance using equity.
what is interest cover
The interest coverage ratio (ICR) is a financial ratio that measures a company’s ability to handle its outstanding debt.
how to calculate interest cover
operating profit / finance cost
what does a decrease in interest cover show
A decrease in the interest cover indicates that the company is facing an increased risk of not being able to meet its finance payments as they fall due
