Processes of Financial Management 2 Flashcards
Financial Ratios
Allow managers to interpret data more effectively, allowing monitoring and controlling
Liquidity / Working Capital
- Tells if business if financially stable in the short term
- If it can pay current liabilities using current assets
- Too much cash can mean the business is not using the funds for use
Liquidity Ratio / Current Ratio
Current Assets / Current Liabilities
- 2:1 acceptable
- Every $1 of liabilities = $2 of assets
Gearing / Solvency (Debt to Equity)
- Ability of a business to meet long term obligations
- Higher debt to equity means greater reliance on debt finance
Debt to Equity Ratio
Total Liabilities / Total Equity
- 1:1 (equal reliance) - 0.6:1 (Safe)
- For every 60c of debt = $1 of equity
Gross Profit
Revenue - COGS
GP Ratio
GP / Sales
40% Ratio = Every $1 of Sales = 40c Profit
Net Profit
GP - Expense
NP Ratio
NP / Sales
10% = $1 in sales = 10c Profit
Return on Owners Equity
How effective funds contributed by owners have been in generating profit
- High ROOE = More efficient use of equity
ROOE Ratio
NP / Total Equity
18% = $1 of OE = 18c in profit
Profitability Ratios
- GP Ratio
- NP Ratio
- ROOE Ratio
Efficiency Ratios
- Expense Ratio
- AR Turnover Ratio
Expense Ratio
Day to day efficiency and financial stability of business, need comparisons to determine efficiency
= Total Expense / Sales
3% = $1 on sales = $0.03 on expenses
AR Turnover
Measures the effectiveness of a business to collect debt owed
- Standard is set at 30 days
AR Turnover Ratio
Sales / AR = x
365 / x = Days on average AR are collected
51 days = Inefficient in collection
Comparative Ratio Analysis
To use ratios efficiently, compare ratios to:
- The same business over time
- Others in the industry
- To a benchmark (standards)
CRA in Isolation
Is ineffective as it can create poor decision making due to:
- Out of context (should be used with other information)
