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Intro to Corporate Finance > Ratio Analysis > Flashcards

Ratio Analysis Flashcards

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1
Q

Why look at Ratios?

A

To see whether the organisation is run properly.

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2
Q

What should you think about when looking at a specific ratio?

A

Why are you doing it, what problem are you wanting to solve, what is this ratio telling me? And What assumptions and Accounting Standards are involved that influence the ratio

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3
Q

What is Liquidity? What is a measure of it?

A

Companies ability to fund its operation on a day to day basis. Current Ratio.

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4
Q

What is Solvency?

A

Companies ability to pay its debts.

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5
Q

What are the 4 main Ratio groups?

A

Profitability
Liquidity and solvency - Cash Position
Operating Efficiency
Investor Ratios

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6
Q

Who might be interested in ratios?

A

Shareholders, Financial Institutions, Suppliers, Customers, Employees, Unions. Competitors

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7
Q

What are the issues when comparing ratios with other companies?

A

Are they in the same sector? Same Size, what do they do compared to you etc?

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8
Q

What are the issues when comparing ratios historically?

A

What about how a growth company matures? Might be Market headwinds one year over another etc. Think about the airline industry and the Covid Crisis etc.
Inflation
Has the accounting standard changed or the assumptions changed.

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9
Q

What is meant by Organisations efficiency?

A

Can it make a product/service. From start to finish.

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10
Q

What is meant by Organisations Effectiveness?

A

Can it make money from a product/service, is it attractive to customers.

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11
Q

What are the issues when looking at a sales figure?

A

Sales could be turnover, but may include sale of businesses. IFRS says you should keep these separate when looking for a ratio that takes into account product sales.

Also Currency fluctuations over the years as well.

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12
Q

What is R.O.S?

A

Return on Sales = EBIT/Sales
Are you Effective!
How much return on £1 of sales.
Margin Over Cost

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13
Q

What might a high R.O.S indicate?

A

That you are effective and providing an attractive product at a good price.

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14
Q

What might a low R.O.S tell you?

A

Could be pricing, cost of production, marketing costs etc.

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15
Q

Generally, what does an organisation need to be to be profitable?

A

Be both effective and efficient.

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16
Q

What is the A.U.R?

A

Asset Utilisation Ratio = Sales/Cap Employed
Shareholders + Long Term Debt
Efficiency Ratio
What investment for £1 in Sales

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17
Q

What are some things to assume with A.U.R?

A

It will assume you can market your product fine, otherwise stuff will just end up on the shelf.

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18
Q

What is R.O.C.E?

A

Return on Capital Employed = EBIT/Cap Employed x 100.
It is a combination of R.O.S and A.U.R. ROS x AUR
What return are you getting from investment.

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19
Q

What are ORPIs

A

Output related performance indicators. Mainly in the Private and not for profit sectors.

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20
Q

What are some of the issues with ORPIs?

A

Can mean that you focus directly on the goal.
Make you short sighted
Tail Wagging the dog

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21
Q

What are a companies sources of Funds?

A

Loans, Equity, Overdrafts etc.

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22
Q

What are the repayment requirements of debt and equity?

A

Debt will need to be re-paid over a defined period and is a constant drain on cash. Equity doesn’t need to be repaid at all in theory but you need to look after your shareholders and make them want to be invested in the company.

23
Q

If you were uncertain about the future, what type of funding would be better?

A

Equity.

24
Q

What is the Current Ratio?

A

Current Assets/Current Liabilities

Measure of Liquidity

25
Q

What would be a good current ratio for a manufacturing business?

A

About 2 or more. Very difficult.

26
Q

What are some of the assumptions made in the Current Ratio?

A

That all assets can be turned to cash at book value, will the raw materials be worth the same?
Would creditors be happy to wait until you have realised all assets, will all debtors/payables give you the money?

27
Q

What is the Quick Ratio and how does it differ to the Current Ratio?

A

Current Assets - Inventory/ Current Liabilities
This gets rid of the problem of not being able to sell your inventory, but will still have the same assumptions about creditors and debtors.

28
Q

What might be a good Quick Ratio?

A

Just above 1
You could sell debt to agency or arrange a smaller payment from debtors. So if this is above 1 it gives a buffer, can always sell inventory etc.

29
Q

What is the Acid Test or Liquidity Ratio?

A

Another name for the Quick Ratio.

30
Q

What is working Captial?

A

Current Assets - Current Liabilities. Will show a buffer.

31
Q

What are the names of the 2 solvency ratios?

A

Leverage and Gearing

32
Q

What is Leverage?

A

Short+Long-Term Debt/ Equity.

USA Term

33
Q

What is Gearing?

A

Short + Long-term Debt/(Equity + Short + Long-term debt) x100
UK/EU Term.

34
Q

Why is Cash so important in a business?

A

Companies will go bust if the don’t have cash to pay debt tax and debtors. You need Cash to pay these!!

35
Q

Profitability ratios can be divided into two basic types. What are these two?

A

Efficiency and Effectiveness.

36
Q

What are you doing when looking at operating efficiency?

A

Looking at the whole business cycle and looking at rations to measure efficiency in each part of the cycle.

37
Q

What are the 4 stages of the production cycle.

A

Supply - Production - Demand - Collection.

38
Q

What is Creditor Days?

A

Creditors or Payables / COGS x365
will show how long you take to pay creditors.
Ideally just less than what required to pay.

39
Q

What is a good approximation for COGS?

A

Cost of Raw Materials + Staff costs.

40
Q

What are you looking at with the Creditor Days ratio?

A

Looking at a number which is just lower than the number of days you need to pay suppliers. This shows you are using the short term credit to your advantage.

41
Q

What is Stock Days?

A

Stock / COGS x 365
Shows how long you are keeping stock
Use Inventory.

42
Q

What might be the problem if Stock Days is high?

A

Unable to sell
Maybe piling inventory due to a forecast supply problem.
Think.

43
Q

What is Debtor Days?

A

Debtors/sales x 365.

Shows how long you take to get paid.

44
Q

Ideally, which ratio should be higher, Creditor or Debtor days?

A

Creditor Days, as you are getting money back quicker than you are paying it out.

45
Q

What is ROE?

A

Return On Equity = Net Profit/Equity

Want Net Profit as you want to know what is available to shareholders.

46
Q

What is the Payout Ratio?

A

Dividends / Profit for the year

The higher the number the better the Dividend.

47
Q

What is the difference between Capital Reserves and Revenue reserves?

A

Retained Profit: Capital Reserves cannot be divided out to shareholders, Revenue reserves can

48
Q

What is Interest Cover?

A

EBIT/ Interest Expense.

Shows how many times they can cover the interest payments.

49
Q

What is Times Interest Earned

A

Another name for interest cover

50
Q

How will Accrual accounting effect some of these ratios?

A

The Balance sheet figures will include receivables that have not been paid, so the cash isn’t there yet. You need cash to pay the debt, interest and Tax.

51
Q

What is EPS?

A

Earnings Per Share = Net Profit / Shares in Circ.

52
Q

What is the PE Ratio

A

Price Earnings = Share Price/EPS

53
Q

What is residual Income?

A

Profit - expected income (dividends)

Investors may expect a specific income per year, say 10%. So this shows what is left over and above this.

54
Q

What is Dividend Cover Ratio?

A

After Tax profit/Total amount of Dividends.

Intro to Corporate Finance (5 decks)

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