Ratio Analysis

Question 1

Where does the information for Ratio Analysis come from?

Answer 1

1. Income Statement

2. Balance Sheet

Question 2

What are the key stages in Ratio Analysis?

Answer 2

1. Gather Data
2. Calculate Ratios
3. Interpret Results
4. Take Action

Question 3

What are the three main groups of ratios?

Answer 3

1. Profitability (Gross profit margin, operating profit margin, return on capital employed)
2. Liquidity (Current ratio, Acid-test ratio)
3. Financial Efficiency (Payable Days, Receivable Days, Inventory turnover, Gearing)

Question 4

Who uses profitability ratios?

Answer 4

1. Shareholders
2. Government
3. Competitors
4. Employees

Question 5

Who uses Liquidity ratios?

Answer 5

1. Shareholders
2. Lenders
3. Suppliers

Question 6

Who uses financial efficiency ratios?

Answer 6

1. Shareholders
2. Lenders
3. Copetitors

Question 7

What are examples of the different levels of profit?

Answer 7

1. Profit from Ordinary Activities before tax. Arrived at by deducting expenses from revenue of ordinary activities.
2. Profit from Ordinary Activities after tax.
3. Net Profit.

Question 8

What are Liquidity Ratios?

Answer 8

Liquidity ratios measure the ability of a business to meet its short-term financial obligations.

Question 9

What are activity ratios?

Answer 9

These measure the effective use of assets.

Question 10

What are Profitability Ratios?

Answer 10

These analyse profit margins in relation to sales and are measures of efficiency.

Question 11

What are Leverage Ratios?

Answer 11

Leverage ratios indicate the amount of external debt funds or borrowings or gearing used in business relative to the amount of shareholder equity.

Question 12

What are Market Performance Ratios?

Answer 12

Market performance ratios are market indicators and outline how an investment is performing in the market in terms of return and security.

Question 13

What is the current ratio formula?

Answer 13

Current ratio = Current Assets / Current Liabilities

Normally expressed as a ratio.

Question 14

What is the Liquid Ratio formula?

Answer 14

Liquid ratio = Current Assets - Inventory - Prepayments / Current liabilities - Bank overdraft

Normally expressed as a ratio.

Question 15

What methods can be implemented for poor liquidity?

Answer 15

1. Encourage cash sales in preference to credit sales
2. Speed up collection of Accounts Receivable
3. Identify and dispose of slow-moving inventory
4. Offer discounts on prompt payment
5. Be more restrictive when offering credit
6. Consider factoring

Question 16

What is the formula for inventory turnover?

Answer 16

Inventory turnover = Cost of goods sold / Average Inventory

Normally expressed as “a number of times for the year”

Number of days inventory is held = 365 (days in a year) / Inventory Turnover

Average Inventory = Opening Inventory + Closing inventory / 2

Question 17

What is the formula for the accounts receivable collection period?

Answer 17

Accounts receivable collection period = Average accounts receivable x 365 days / Credit Sales

Normally expressed in days.