Ratio Analysis Flashcards
Why is profit so important in a business?
Profit is
- a return on investment
- a reward for taking risks
- a key source of finance
- a measure of business success
- a motivating factor and incentive
What do profitability ratios do?
Assess the returns earned by a business from its trading activities and investments
What are the two ways of measuring profit
- profit in absolute terms
- profit in relative terms
What financial statement is linked to profitability
Statement of comprehensive income
Define the statement of comprehensive income statement
Measures business performance over a given period of time, usually one year. It compares the incomes of the business against the costs of goods or services and expenses incurred in the earning that is revenue
What are the four key profitability ratios
- GPM
- OPM
- NPM
- ROCE
Gross profit calculation
Sales rev- cost of sales
Operating profit
Gross profit - operating expenses
Profit of the year
Operating profit - interest/taxation
Gross profit margin
GP/ SALES REV X 100
OPM
OP/SALES REV X 100
NPM
NET PROFIT/SALES REV X 100
How is capital employed calculated ?
Total equity + non current liabilities
Return on capital employed
Operating profit/capital employed x 100
What do liquidity ratios asses?
Whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due
Where are liquidity ratios found?
The statement of financial position (balance sheets)
What is a current ratios
Current assets:current liabilities
What is acid ratio
Liquid assets:current liabilities
What category is a mortgage found in?
Non-current liability
What are examples of current assets
Inventory
Cash and cash equivalents
Cash receivables
What does a ratio of 1.5-2.5 suggest about a business liquidity?
-efficient management of working capital and acceptable liquidity
What are covered as overheads?
- office salaries
- expenses claims
- rent
- admin costs
What does net profit represent ?
The bottom line-
This explores what a business has left to reinvest or return to shareholders (in the forms of dividends) after tax has been deducted
Why might a manager want access to the income statement
They could rev, gross profit and operating profit to measure the performance of the business and to set targets
Why might a shareholder be interested in the income statement
They will be interested so they can indicate if potential returns to shareholders can be made from the net profit
Government interests in income statement ?
- to identify the level of taxation the business needs to pay back to HMRC
What are provisions?
Money put aside in anticipation of bad debt- customers failing to pay up
What does total equity represent
How the business is being financed
Stakeholder interests in the statement of financial position
Shareholders - may analyse asst structure of the business to see how their investments has been spent
Suppliers/creditors- will be interested to see whether a business can pay its debts or not, and support any decisions around credit disagreements
