Ratio Analysis (3.5.2)

Question 1

What are financial statements and what is negative about them?

Answer 1

Financial Statements provide a snapshot of how the business is currently performing. However, the raw data of financial statements can sometimes be difficult to interpret to make an accurate assessment.

Question 2

What are ratio analysis’s?

Answer 2

Use of a combination of ratios to assess whether the business should go ahead with a certain decision

Question 3

What are the three types of ratio analysis’s?

Answer 3

Profitability
Liquidity
Gearing

Question 4

What do each of these ratios mean?

Answer 4

Profitability-Shows the relationship between Gross, Operating and Net Profit, Revenue, Assets and Capital

Liquidity-Shows the ability to meet short-term debts with its cash or current assets

Gearing-Shows the proportion of long-term finance that has come from borrowing

Question 5

What does the Current Ratio mean and what is the formula?

Answer 5

Current Assets/ Current Liabilities

Shows the ability of a business to meet their short-term debts

Question 6

Current Ratio values what do they mean? (>1-2.5+)

Answer 6

> 1-Firm cannot pay short-term debts.
1.0-Firms can just about pay short-term dates.
1.5-2 -when the firm can comfortably pay its short-term debts.
2.5+ -Firm is potentially too liquid

Question 7

What does the Acid Test Ratio mean and what is the formula?

Answer 7

(Current Assets-Inventory)/Current Liabilities

Shows the ability of a business to meet their short-term debts without having to sell inventory

Question 8

Acid Test Ratio values what do they mean? (>1-2.0+)

Answer 8

> 1-Firm has to sell stock to pay short-term debts.
1.0-Firm can just about pay short-term debts without selling stock.
1.5-Firm can comfortably pay its short-term debts without selling stock.
2.0+-Firm is potentially too liquid.

Question 9

What is a Gearing Ratio?

Answer 9

Measures the level of debt a business has. Shows how reliant a business is on borrowed money.

Question 10

What is Capital Employed? Including Formula

Answer 10

Share Capital+ Retained Profit + Non-current Liabilities

Measures how much capital is going towards making a profit. Capital can come from investors, retained profit or from borrowing

Question 11

What is the Gearing Ratio formula? What does it show?

Answer 11

(Non-Current Liabilities/ Capital Employed)x100

Shows % of Capital employed that comes from long-term borrowing

Question 12

The higher the gearing ratio the higher the what?

Answer 12

Risk of failure. Anything above 50% is highly geared

Question 13

What are the advantages of High Gearing?

Answer 13

-Less investment pressure on shareholders
-Interest rates may be cheaper than dividends
-Easy to pay interest if rev/profit is strong

Question 14

What are the advantages of Low Gearing?

Answer 14

-Higher risk of defaulting on debts
-More power with shareholders vs banks
-Can add debt more freely to expand

Question 15

What are the 4 Profitability Ratios?

Answer 15

-Gross Profit Margin
-Operating Profit Margin
-Net Profit Margin
-ROCE

Question 16

What does ROCE stand for?

Answer 16

Return on Capital Employed

Question 17

What do Profit Margins show?

Answer 17

Show how well a business is managing its Revenue and Costs

Question 18

What are the Profit Margin Formulas?

Answer 18

(Gross Profit/ Sales Revenue) x100
(Operating Profit/ Sales Revenue) x100
(Net Profit/ Sales Revenue) x100

Question 19

What do these three formulas tell you?

Answer 19

% of how much profit is made for every £1 of Revenue.
e. g GPM=40% meaning 40p of every £1 is Gross Profit.

Question 20

What is the formula for Return on Capital Employed? What does it show?

Answer 20

(Operating Profit/Capital Employed) x100

Shows return on investment from investing capital into the business.

Question 21

What is Return on Capital Employed?

Answer 21

Financial ratio that measures a company’s profitability in terms of all of its capital. Assesses how efficiently a company uses its capital to generate profits.

Question 22

Is it better for the ROCE % to be higher or lower?

Answer 22

Higher

Question 23

What could a low ROCE result in?

Answer 23

Liquidation

Question 24

What does ROCE do?

Answer 24

-Evaluate business performance internally
-Track performance over time
-Provides target return for projects
-Compare with competitors

Question 25

What are ways to improve ROCE?

Answer 25

-Pay off loans while maintaining profit
-Buy back shares while maintaining profit
-Reinvest retained profit
-Increase OP without increasing Capital Employed

Question 26

What are the limitations of Ratios?

Answer 26

-Expansion
-Economic impact
-Qualitative data
-Comparisons
-Quality of past data
-Managers skill

Question 27

What is the role of Human Resources (HR)?

Answer 27

Measuring and improving the performance of the people within a business. This can have a major impact on the success of a business.

Question 28

Motivated and Unmotivated staff what are the like?

Answer 28

Motivated- Productive, punctual and add value to the company.

Unmotivated- Lazy, late and devalue the company.

Question 29

What are the four motivational theories?

Answer 29

-Taylor’s Scientific Management
-Maslow’s Hierarchy of Needs
-Herzberg’s Two factor theory
-Mayo’s Human relations theory

Question 30

How can you improve employee performance?

Answer 30

-Financial Rewards
-Employee Share Ownership
-Consultation strategies
-Empowerment strategies