Ratio Analysis

Question 1

What is the purpose of ratio analysis and where is the main amount of information found.

Answer 1

To create a figure in order to be able to compare business performance and identify key areas in the business that need improving. Information to work out the ratios is found in a balance sheet, income statement and a statement of financial position

Question 2

Types of ratios.

Answer 2

Financial efficeny
Liquidity
Profitability

Question 3

Profitability ratios

Answer 3

Gross profit margin
Net profit margin
Operating profit margin
Return on capital employed (ROCE)

Question 4

Net profit margin formula

Answer 4

Net profit
—————— X 100.
Sales revenue

Question 5

Operating profit margin

Answer 5

Operating profit - Profit before the expenses of taxation

Operating profit
——————- x100
Sales revenue

Question 6

Gross profit margin

Answer 6

Gross profit
—————— X100
Sales revenue

Question 7

Return on capital employed

Answer 7

Operating profit
————————————————
(Total equity + Non - current liabilities.)

Question 8

Liquidity ratios

Answer 8

Current ratio

Acid test ratio

Question 9

Current ratio

Answer 9

Current assets
———————
Current liabilities

Question 10

Acid test ratio

Answer 10

(Current assets - stock)
——————————
Current liabilities

2.5% or higher is considered a good result

Question 11

Financial efficiency ratios

Answer 11

Debtor days
Creditor days
Gearing ratios
Inventory turnover.

Question 12

Debtor days

Answer 12

Debtors
———— X 365
Revenues

Question 13

Creditor days

Answer 13

Creditors
—————- X365
Cost of sales

Question 14

Gearing ratios

Answer 14

Non current liabilities (Loans)
——————————————— X100
(Total equity + non current liabilities)(Loans)

Cost of sales
—————————————-
Average inventories (stock held.)

Question 15

Limitations of current ratios

Answer 15

Varies due to the type of business
Firms have different inventory holding requirements
The trend shows more rather than the initial result

A figure of 2.5% or more is considered good in acid test ratios

Question 16

Limitations of ROCE

Answer 16

Varies again between industries

Comparisons over tine are more useful

Question 17

Gearing ratios limitations and indicators

Answer 17

Depends on the business
50% is too high
20% is too low

Question 18

Financial ratios limitations and indicators

Answer 18

Payable days need to be higher than receivable days

Too high suggests liquidity problems

Question 19

Limitations of ratio analysis in general

Answer 19

Based on the past
Data can be manipulated
One set of data is never enough
Comparability between businesses.

Question 20

Purpose of ratios and specific purposes

Answer 20

Used to measure different types of business performance
How is the business trading
Is the business in a strong financial position
Prospects for the business

Profitability
—————

Is the business making a profit
Status of investment
Sustainable
Quality

Financial efficency
————————
Best use of resources 
Generating adequate returns on investment 
Managing its working capital properly

Liquidity and gearing 
—————————
Short term debts payable?
Raising enough finance 
how risky is financial structure 
Generating enough cash

Shareholder return
————————

What returns are the owners getting
How does it compare to other businesses

Question 21

Shareholder Ratios

Answer 21

Dividend per share

Total dividends
——————————————
Number of issued ordinary shares

Dividend per yield

(Ordinary share dividend in pence)
(——————————-) X100
(Current market in pence)7

Question 22

Capital employed

Answer 22

Net assets + long term liabilities

Question 23

Asset turnover

Answer 23

Revenue
——————-
Net assets