Ratio analysis

Question 1

What is Turnover

Answer 1

The overall business Revenue

Question 2

Define Gross Profit

Answer 2

The difference between the revenue from selling the product and the direct costs of making it

Question 3

Formula for gross profit

Answer 3

Sales Revenue - Costs of Sales

Question 4

Formula for gross profit margin

Answer 4

Gross profit / Turnover x 100

Question 5

Define Net profit

Answer 5

It is the profit that follows the reduction of all expenses from the gross profit.

Or total profit made minus all expenses

Question 6

Formula net profit

Answer 6

gross profit - all expenses
or
TR-TC

Question 7

Formula for net profit margin

Answer 7

net profit / turnover x 100

Question 8

Formula for capital employed

Answer 8

Shareholders’ Equity + Non-Current Liabilities

Question 9

Define ROCE

Answer 9

ROCE shows the profitability of the investment

This measures the efficiency with which the business generates profits from the capital invested in it.

The higher the better

Question 10

Formula for ROCE

Answer 10

Operating (net) Profit/Capital employed x 100

Question 11

Define Gearing Ratio

Answer 11

Gearing is a measure of how much of a company’s operations are funded using debt versus the funding received from shareholders as equity.

40-50 optimal

Question 12

Formula for Gearing Ratio

Answer 12

Long-term liabilities/capital employed x 100

Question 13

Formula for Current Ratio

Answer 13

Divide the current assets by the current liabilities

Question 14

Formula for acid test ratio

Answer 14

Current assets – stocks divided by current liabilities

Question 15

Define Current ratio

Answer 15

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or those due within one year.

2:1 ratio is healthy

Question 16

Define Acid test ratio

Answer 16

The acid-test, or quick ratio, compares a company’s most short-term assets to its most short-term liabilities to see if it has enough cash to pay its immediate liabilities

2:1 ratio is healthy

Question 17

Formula working capital

Answer 17

Current assets - Current liabilities

Question 18

Define capital employed

Answer 18

Refers to the money invested into the business includes shareholder funds

Question 19

If capital employed (shareholder funds and long term liabilities) increases what happens

Answer 19

If this increases it can mean that the shareholders are using capital to invest in long term expansion such as opening new locations

Question 20

What are the limitations of ratio analysis

Answer 20

• A range of ratios is more valid – too much importance should not be attached to any single ratio.
• Major one-off transactions may distort the true performance of a company.
• The financial accounts may have been ‘window dressed’.