Ratio Analysis

Question 1

Why is profit so important in a business?

Answer 1

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

Question 2

What do profitability ratios do?

Answer 2

Assess the returns earned by a business from its trading activities and investments

Question 3

What are the two ways of measuring profit

Answer 3

• profit in absolute terms

- profit in relative terms

Question 4

What financial statement is linked to profitability

Answer 4

Statement of comprehensive income

Question 5

Define the statement of comprehensive income statement

Answer 5

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

Question 6

What are the four key profitability ratios

Answer 6

• GPM
• OPM
• NPM
• ROCE

Question 7

Gross profit calculation

Answer 7

Sales rev- cost of sales

Question 8

Operating profit

Answer 8

Gross profit - operating expenses

Question 9

Profit of the year

Answer 9

Operating profit - interest/taxation

Question 10

Gross profit margin

Answer 10

GP/ SALES REV X 100

Question 11

OPM

Answer 11

OP/SALES REV X 100

Question 12

NPM

Answer 12

NET PROFIT/SALES REV X 100

Question 13

How is capital employed calculated ?

Answer 13

Total equity + non current liabilities

Question 14

Return on capital employed

Answer 14

Operating profit/capital employed x 100

Question 15

What do liquidity ratios asses?

Answer 15

Whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

Question 16

Where are liquidity ratios found?

Answer 16

The statement of financial position (balance sheets)

Question 17

What is a current ratios

Answer 17

Current assets:current liabilities

Question 18

What is acid ratio

Answer 18

Liquid assets:current liabilities

Question 19

What category is a mortgage found in?

Answer 19

Non-current liability

Question 20

What are examples of current assets

Answer 20

Inventory
Cash and cash equivalents
Cash receivables

Question 21

What does a ratio of 1.5-2.5 suggest about a business liquidity?

Answer 21

-efficient management of working capital and acceptable liquidity

Question 22

What are covered as overheads?

Answer 22

• office salaries
• expenses claims
• rent
• admin costs

Question 23

What does net profit represent ?

Answer 23

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

Question 24

Why might a manager want access to the income statement

Answer 24

They could rev, gross profit and operating profit to measure the performance of the business and to set targets

Question 25

Why might a shareholder be interested in the income statement

Answer 25

They will be interested so they can indicate if potential returns to shareholders can be made from the net profit

Question 26

Government interests in income statement ?

Answer 26

• to identify the level of taxation the business needs to pay back to HMRC

Question 27

What are provisions?

Answer 27

Money put aside in anticipation of bad debt- customers failing to pay up

Question 28

What does total equity represent

Answer 28

How the business is being financed

Question 29

Stakeholder interests in the statement of financial position

Answer 29

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