Ratio Analysis Flashcards
What’s the formula for gross profit on sales
Gross profit/sales x 100
Formula for gross profit/cost of sales
Gross profit/cost of sales x 100
Comment on gross profit on sales
-sales prices incorrectly marked
-too much trade discounts
-goods are being sold for less than mark up policy
Recommendation for gross profit on sales
-check pricing
-avoid too much discount
Explain gross profit on sales
It shows what percentage of selling price is available to cover operating expenses
Comment on gross profit on cost of sales
-prices are incorrectly marked
-too much trade discount
-goods are being sold for less than the markup policy
Explain operating profit on sales
Determines whether expenses are being managed well or not
Comment on operating profit on sales
-If lower,insufficient control over expenses
-The higher the better expenses are being managed
Recommend for operating profit on sales
If amount got lower increase the control over expenses
Explain net profit on sales
Tells us how efficiently business is being managed
Comment on net profit on sales
It should not be lower than 1/3 of percentage gross profit on sales
Explain percentage operating expenses on sales
Shows the part of gross profit used for operating
Tells us how much control we have over stocks
Comment on operating expenses on sales
Lower the percentage the better expenses are being managed
If amount decreased there was better cost control
If amount increased there was poor control over expenses
Recommend for operating expenses on sales
There must be better control over costs
Advertising expenses should be in relation to sales
When is a business regarded as solvent
When total assets are more than total liabilities
When is a business regarded as insolvent
When the total assets are less then the total liabilities
Solvency ratio
When the ratio is 1:1 or more the business is regarded as solvent
Insolvency ratio
When the ratio is less then 1:1
What is working capital
Current assets -current liabilities
What does liquidity tell us
How much cash we have to cover our liabilities
Comment on liquidity
If ratio is too high (<2:1)
-there is too much stock
-wrong stock
-prices are too high
If ratio is too low (>2:1)
-obsolete stock
-stock valued higher than realistic value
-increase in credit sales
Recommend if current ratio is too low
Check stock levels
Check obsolete stock
Check whether or not prices are too high
Explain acid test ratio
Explains whether or not business can cover short term expenses or not without having to sell stock
Explain the ratios for acid test ratio
If the ratio is less than 1:1 business can’t afford to cover short term expenses without selling stock
And vice versa
Why is the acid test ratio low
-debtors are taking too long to pay us
-we are paying creditors too soon
Recommend for acid test
-Offer discounts to debtors for early payment
-take the maximum amount of time to pay creditors
Net asset
Total assets -total liabilities
Net current assets
Current assets-current liabilities
Capital employed
Sum of equity and non current liabilities
Liquid assets
Cash and cash equivalents +trade and other receivables
Average debtors collection period formula
Opening balance on debtors + closing balance on debtors divide by 2
How well is business controlling their debtors
Average debtors =tells us whether or not people are complying with allocated time to pay
Formula for average debtors collection period
Average debtors divided credit sales x 365 = days
Comment on average debtors collection period
The longer the debtors take to pay
-negative effect on liquidity of business
-it affects available working capital
-credit term policy is not efficient
Methods to improve the collection period
Charge interest on overdue debtors
Offer discounts to early payments
No more sales to debtors with over due amounts
Regular follow up with debtors telephonically
Average creditors on payment period formula
Average creditors divide credit purchases x365=days
Explain average creditors on payment period
Determines whether there is compliance with creditors
Determines whether business is keeping up with internal payment policy so that
Discounts are received
No interest on overdue accounts is charged
Suppliers do not stop supplying us
Comment on average creditors payment period
If debtors are taking longer to pay than the business is paying its creditors it may cause cash flow problems
Recommendations for average creditors payment period
Pay on time
Do not pay early
Don’t pay too late
Debt equity ratio (gearing ratio)
Non current liabilities:owners equity
Explain debt equity ratio
Indicates how the business is financed and therefore indicates the degree of financial risk
Comment on debts equity ratio
If less than 1:1 that means
-loans are not too high
-advantage to business
-business has a good credit rating
If ratio is more than 1:1
Loans are too high
-interest must be paid
-disadvantage to business
Recommend for debt equity ratio
To decrease the loans
Partners earnings formula
Partners earnings divide by average partners equityx100
Explain partners earnings
Partners want to know if they made the right decision investing in business as a pose to other investments
Return on partners equity formula
Net profit divide average partners equity x100
Return on partners equity explain
Each partner wants to know if they’re return is worth it
