Ratio Analysis (profitability, efficiency and liquidity )

Question 1

Return on capital employed (profitability)

Answer 1

Profit before interest and tax/ capital employed

X 100

Capital employed= shareholder funds + non current liabilities

(%)

(What return the company is getting on all of its capital

Question 2

Returns on equity (profitability)

Answer 2

Profit after interest and tax/ equity

X 100

(%)

Equity - ordinary share capital and reserves

Question 3

Net profit margin (profitability)

Answer 3

Net profit attributable to equity holders/ sales

X 100

(%)

Question 4

Gross profit margin (profitability)

Answer 4

Gross profit/ sales

X 100

(%100)

Question 5

Asset turnover (efficiency)

Answer 5

Sales/ net assets

(X times) not a percentage

Question 6

Trade receivables collection period (efficiency)

Answer 6

Average trade receivables / credit sales

X365

(X days )

The fewer days the better

Discounts could be offered to encourage earlier payments

A high number of days could indicate bad debts

Question 7

Trade payables days (efficiency)

Answer 7

Average trade payables/ purchases on credit

X 365 days

(X days)

Higher days figure better, however if the payment is too late then suppliers may refuse to offer credit

Overtrading- when a business increases sales too quickly. Purchase of inventory will increase and the business may be unable to pay creditors as they fall due

Question 8

Inventory turnover (efficiency )

Answer 8

The rate at which inventory is turned over/ the time before inventory is sold

Cost of sales / average inventory = x times

Or

Average inventory / cost of sales

x 365 days

(X days)
Average inventory = opening stock + closing stock /2

Question 9

Current ratio (liquidity)

Answer 9

Current assets / current liabilities

= x:1

A measure of whether a business can pay its current liabilities without using non current assets

2:1 normally desirable but depends on the type of business

Question 10

Quick ratio (acid test/ liquid ratio )

Liquidity

Answer 10

Current assets- inventory / current liabilities

=x:1

Quick ratio tells how readily we can pay off our short term creditors, as a rule 1:1 is acceptable however supermarkets may be much lower

Question 11

Working capital cycle (liquidity)

Answer 11

A business would always like to receive money in before it needs to pay it out

Inventory turnover period X
Trade receivables Collection X
Trade payables payment period (X)
_

Cash operating cycle X