Ratio Analysis (3.5.2) Flashcards
What are ratio analysis’s?
Use of a combination of ratios to assess whether the business should go ahead with a certain decision. Extracting information from financial accounts to assess business performance.
What bits of information is shown on the Profit and Loss Account and the Balance Sheet?
Profit and Loss Account:
-Revenue
-Cost of Sales
-Gross Profit
-Operating Profit
-Profit for the Year (Net profit)
Balance Sheet:
-Current Assets
-Current Liabilities
-Inventory (stock)
-Trade Receivables
-Trade Payables
-Long-term liabilities
-Capital & Reserves
What does Ratio analysis support?
Supports evidence-based decision making as it provides measurable data that can be used to support judgements and compare performance against objectives
What are the steps in the Ratio Analysis Process?
- Collect Data
- Calculate Ratios
- Interpret results
- Use to make decisions
What are the three types of ratio analysis’s?
Profitability
Liquidity
Gearing
What do each of these ratios mean?
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 LT financial structure of business. Shows balance of NC liabilities (LT loans) to shareholders capital used to fund a business
What are the 4 Profitability Ratios?
-Gross Profit Margin
-Operating Profit Margin
-Net Profit Margin
-ROCE
What does ROCE stand for?
Return on Capital Employed
What is Return on Capital Employed?
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.
What does ROCE do?
-Evaluate business performance internally
-Track performance over time
-Provides target return for projects
-Compare with competitors
What is the formula for Return on Capital Employed? What does it show?
(Operating Profit/Capital Employed) x100
Shows return on investment from investing capital into the business.
Is it better for the ROCE % to be higher or lower?
Higher
What could a low ROCE result in?
Liquidation
What are ways to improve ROCE?
-Pay off loans while maintaining profit
-Buy back shares while maintaining profit
-Reinvest retained profit
-Increase OP without increasing Capital Employed
What do Profit Margins show?
Show how well a business is managing its Revenue and Costs
What are the Profit Margin Formulas?
(Gross Profit/ Sales Revenue) x100
(Operating Profit/ Sales Revenue) x100
(Net Profit/ Sales Revenue) x100
What is a Gearing Ratio?
Measures the level of debt a business has. Shows how reliant a business is on borrowed money.
What is Capital Employed? Including Formula
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
What is the Gearing Ratio formula? What does it show?
(Non-Current Liabilities/ Capital Employed)x100
Shows % of Capital employed that comes from long-term borrowing
What are the advantages of High Gearing?
-Less investment pressure on shareholders
-Interest rates may be cheaper than dividends
-Easy to pay interest if rev/profit is strong
What are the advantages of Low Gearing?
-Higher risk of defaulting on debts
-More power with shareholders vs banks
-Can add debt more freely to expand
The higher the gearing ratio the higher the what?
Risk of failure. Anything above 50% is highly geared
What does the Current Ratio mean and what is the formula?
Current Assets/ Current Liabilities
Shows the ability of a business to meet their short-term debts
Current Ratio values what do they mean? (>1-2.5+)
> 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
What does the Acid Test Ratio mean and what is the formula?
(Current Assets-Inventory)/Current Liabilities
Shows the ability of a business to meet their short-term debts without having to sell inventory
Acid Test Ratio values what do they mean? (>1-2.0+)
> 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.
What are the limitations of Ratio Analysis?
-Expansion
-Economic impact
-Qualitative data is only numerical so doesn’t take into account quantitative factors
-Comparisons only useful if similarities
-Quality of past data as could be manipulated
-Managers skill
-Balance Sheet Limitations as ‘snapshot’ of business so not representative
What is the role of Human Resources (HR)?
Measuring and improving the performance of the people within a business. This can have a major impact on the success of a business.
Motivated and Unmotivated staff what are the like?
Motivated- Productive, punctual and add value to the company.
Unmotivated- Lazy, late and devalue the company.
What are the four motivational theories?
-Taylor’s Scientific Management
-Maslow’s Hierarchy of Needs
-Herzberg’s Two factor theory
-Mayo’s Human relations theory
How can you improve employee performance?
-Financial Rewards
-Employee Share Ownership
-Consultation strategies
-Empowerment strategies
