Ratio Analysis Flashcards
why are ratios calculated for several different time periods
to enable users to make comparisons to see if ratios are rising, falling or staying the same
what are the advantages of using ratios
easy to calculate and understand
simplify data into key indicators to hghlight trends and variances
what are the three types of ratios
efficiency
profitability
performance
what are the profitability ratios
gross profit percentage
operating profit percentage
return on capital employed
return on ordinary shareholders’ funds
what does the gross profit percentage asses
how efficiently entities are controlling their production costs/ costs of buying goods for resale
how to calculate gross profit percentage
gross profit / revenue x100%
what are some possible reasons for changes in gross profit %
selling prices rising faster/more slowly than costs of goods sold
rising/falling in prices of materials/goods brought in
increased/decreased productivity in the workforce
supplier bulk discounts reduce costs
bulk discounts to customer reduce revenue
what does the operating profit assess
changes in distribution and selling costs and admin expenses
how to calculate operating profit %
operating profit / revenue x 100%
what does return on ordinary shareholders funds assess
the amount of profit for the period available to owners with their average investment in the business during that same period
how to calculate return on ordinary shareholders’ funds
profit for the year/ total equity x100
What does return on capital employed assess
measures the returns to all suppliers of long-term finance before any deductions for interest payable on borrowings, or payments of dividends to shareholders, are made
ie how high are turns from their capital structures
how to calculate the return on capital employed
operating profit/(equity + non current liabilities) x100
what are some problems associated with the return on capital employed
not all assets used to generate profit are presented in entities’ SoFPs
SoFP figures do not represent current values
All figures need adjusting for inflation
Total shareholder return is a better indicator of investment returns available from companies
what do efficiency ratios measure
how effectively and productively the resources of the organisation are being used in the generation of revenue and profit
what are the two types of resources used in measuring efficiency ratios
non current assets
employees
what are the efficiency ratios
non current asset turnover
revenue per employee
sales per employee
what does no current asset turnover measure
efficiency of the non current assets being used to generate sales
how to calculate the non current asset turnover
revenue/ non current assets
how might the non current assets turnover be inaccurate
careful of when assets were bought. If they are still valued at their cost price this is inaccurate
how to calculate revenue per employee
revenue / #employees
how to calculate profit per employee
profit /#empoyees
where can # of employees be found
annual report
what are the performance ratios
dividend per share earnings per share price earnings ratio dividend yield dividend cover
what does earnings per share measure
profit earned during each accounting period by an ordinary share
if all profits were paid out as dividends, what would be paid out to shareholders
how to calculate earnings per share
profit after tax / #ordinary shares
why is earnings per share an important figure for the stock market
will determine share prices
what does price earnings ratio measure
how many years of current period earnings are represented in today’s share price
what does a higher price earnings ratio mean
higher confidence in the company
steady profits as dividends from these shares are more certain
what does a lower price earnings ratio mean
volatile profits and dividends will be much less certain
how to calculate price earnings ratio
market value of one ordinary share / eps
what does dividends per share measure
the dividends in pence paid out on each ordinary share
the ideal circumstance for the shareholders is that the dividends per share increases or decreases each year
increases
how to calculate dividends per share
total ordinary dividends/ # ordinary shares x100pence
how to calc the dividend pay out ratio
dividend per share / earnings per share x 100%
what does the dividend pay out ratio measure
the % of earnings per share distributed as dividend per year
how do the dividend yields compare to interest rates in a bank account
is it better to put the money into a bank account with an interest rate or is it better to risk putting them into shares and potentially getting higher yields
how to calculate dividend yeild
dividend per share / current market price of one ordinary share x100
how to calculate dividend cover
profit after tax / total ordinary dividend
what does dividend cover measure
how many times the current year ordinary dividend can be paid from profit for the year
when does overtrading occur
where a business is operating at a level of activity that cannot be supported by the amount of finance that has been committed
what does overtrading result in
liquidity problems
suppliers withholding supplies
what is liquidity
entities’ ability to raise cash to pay off liabilities as they become due for payment , if unable to generate this cash, it cannot pay debts or survive so will file for bankruptcy
do retailers generate cash quickly or slowly
quickly as customers pay cash for goods
do manufacturers generate cash quickly or slowly
slowly as sell to customers on credit and so have to wait for payment
what does current ratio measure
how msny €s of current assets an entity has for each € of liabilities
determines if the organisation has enough short term assets from which to meet short term liabilities
how to calculate current ratio
current assets/current liabilities
what is the recommended ratio for current assets to current liabilities
2:1
what is the current ratio determined by
how quickly cash is generated
what does quick ratio measure
assumes that inventory will not sell as quickly
current assets to current liabilities
how to calculate quick ratio
current assets - inventories / current liabilities
what is the recommended quick ratio
1:1
what is working capital
current assets - current liabilities
what do working capital ratios measure
how quickly inventory is sold, how quickly trade receivables are turned into cash and how quickly trade payables are paid
what are the 3 working capital ratios
inventory days
receivable days
payables days
what does inventory days measure
the average stockholding period
is higher or lower inventory days bette
lower
how to calculate inventory days
closing inventory/cost of sales x365
why is it better to have a higher turnover of stock
cash more readily
less risk of deterioration of stock
lower storage costs
what does receivables days measure
the average credit period taken by credit customers
how to calculate receivables days
closing trade receivables/credit sales x365
does a business usually want higher or lower receivables days
lower
if the receivable days are getting too high, what incentives can be used to help reduce inventory days
discounts
what do payables days measure
average credit period taken by an entity to pay its suppliers
how to calculate payables days
closing trade payables / cost of sales x365
ideally how should payables be paid
using money received from receivables
what is the cash conversion cycle
how quickly inventory is turned into trade receivables and these trade receivables are turned unto cash with is used to pay trade payables
how to calculate cash conversion cycle
inventory days + receivable days - payable days = cash conversion cycle
is a short cash cycle or longer better
shorter
what are the long term solvency ratios
gearing ratio
debt ratio
interest cover
what is long term solvency
an organisation’s ability to meet the interest on repayment of long term, non current liabilities as they fall due
what is financial stability
the avoidance of excessive borrowings, consistency of demand for products and services and the ability to innovate to stay relevant
what does gearing ratio measure
total borrowings as a percentage of equity
measure of risk
how to calculate gearing ratio
long+short term borrowings / equity x100
what does the debt ratio measure
the number of euros of liabilities to euros of assets
how to calculate the debt ratio
total liabilities / total assets
is a lower or higher debt ratio better
lower as it is more secure as there are more assets to cover the liabilities
what does interest cover measure
how many times interest payable on borrowings can be paid from operating profit
is a higher or lower interest cover better
higher
indicated that they can continue to make interest payments into the future
how to calculate interest cover
profit before interest and tax/interest expense
what else can be used to measure long term financial stabliity
how consistent is demand
how strong are cash flows
how many years before the repayment of borrowings is due, is the interest rate fixed or variable
what compnies should ratios be compared to
those: in similar industry in similar locations of similar size with the same accounting period
what else should the ratios be compared to other than other companies
against budgeted/planned data
against industry averages
what is the cash flow cycle of retailers
goods purchased on credit from suppliers -> goods sold to customers for cash -> cash used to pay suppliers and other claims
what does the cash flow cycle look like for manufacturers
raw materials purchased on credit from suppliers
->
raw materials turned into finished goods
->
finished goods sold on credit to customer
->
cash used to pay suppliers and other credits
->
customers pay what is owed on due date
when borrowing risk should be evaluated by:
affordability interest repayment dates operating cash inflows (how much cash will be on hand) consistency of product demand
if cost of sales is not provided how should working capital ratios be calculated
using revenue
