Ratio analysis Flashcards
what is a balance sheet
a snapshot of the business’ assets and its liabilities on a particular day
what are non-current assets
assets unlikely to use in a year e.g.
- land and buildings
- plant and machinery
- goodwill
what are current assets
assets likely to use in one year e.g.
- cash balances
- trade debtors (receivables)
- inventories
what are current liabilities
liabilities likely to pay back in a year e.g.
- trade creditors (payables)
-short-term borrowings
accruals and provisions
what are non-current liabilities
liabilities not likely to pay in a year e.g.
- long-term borrowings
- other long term liabilities
what is current ratio
assess whether a business has to be sufficient cash or equivalent current assets to be able to pay its debts as they fall due
how do you find current ratio
current assets/current liabilities
what does a ratio of 1.5-2.5 suggest
acceptable liquidity and effect management of working capital
what does a low ratio suggest
indicates liquidity issues
what does a high current ratio suggest
too much working capital tied up in inventories/debtors
- may have too much stock
- may have too much debt owed
- not using resources - cash sat doing nothing - should grow business
why do supermarkets have a low ratio?
don’t pay people back for 60-90 days but raise rev. quickly
can you compare ratio across industry
No, firms have different requirements for holding inventories or approaches to trade debt and credit
why is trend important in current ratio
sudden deterioration in current ratio = good indicator of liquidity problems
what is a gearing ratio?
measures proportion of business’ capital provided by debt
why is gearing ratio useful
measure financial health business
what does high gearing indicate
high business risk
how do you find gearing ratio
(non-current liabilities/total equity + non-current liabilities) x 100
what is considered a high gearing ratio
over 50%
what is considered a low gearing ratio
lower than 20%
what does level of acceptable gearing depends on
industry
can you compare gearing across industries
no
why is return on capital employed important
- evaluate overall performance of business
- provide target return for individual projects
- benchmark performance w/ competitors
how do you find ROCE
(operating or net profit/ total equity + non-current liabilities) x 100
when is ROCE most useful?
comparison over time with key competitors
what are trade payables?
money you have to pay someone else
what are payable days?
time you have to pay someone back
what are trade receivables
money someone else has to pay you
what are receivable days
time others have to pay you back
is it better that payable or receivable days are longer?
payable days longer than receivable days - good for cash flow
why are low payable days good?
- better relationship with supplier
- can bargain lower prices
- supplier will prioritise you if there is a shortage of that item
how do you calculate receivable days
(trade receivables / revenue) x 365
how do you calculate payable days
(trade payables / cost of sales) x 365
if payable days are too high what does this suggest?
liquidity issues
what does a low current ratio suggest about payable days
means payable days are high - severe cashflow problems
what don’t ratios tell you
- competitive advantage
- quality
- ethical production
- future production
- changes in external environment
