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Application > Ratio calculations and investment > Flashcards

Ratio calculations and investment Flashcards

1
Q

profitability (%)

A

type of profit/revenue X100
(gross profit)
(Operating profit)
(net profit)

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2
Q

What is return on capital employed (ROCE)

A

measures profit generated by the business from assets owned by the business

(the larger the better)

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3
Q

How to calculate return on capital employed (ROCE)

A

(operating profit/capital employed) X100

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4
Q

Capital employed

A

total assets- current liabilities

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5
Q

What are the two liquidity measures

A

current ratio

acid test ratio

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6
Q

CURRENT ratio

A

current assets/current liability

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7
Q

Acid test ratio

A

(current assets-stock)/current liability

Acid erodes stock

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8
Q

Liquidity

A

the amount of cash a business has to cover its short term liability

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9
Q

Gearing ratio definition

A

percentage of business assets bought using borrowed finance

The you need to buy gears using borrowed finance

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10
Q

Gearing ratio calculation

A

(Non current liabilites/ capital employed) X100

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11
Q

What is investment

A

spending on capital equipment used to make products

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12
Q

Pay back calculation

A
  1. minus annual returns from investment to work out how many years it will take
  2. (what is still owedl/ remaining payback) X12
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13
Q

define payback

A

the amount of time it takes for an investment to repay its cost.

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14
Q

disadvantages of payback

A
  1. based on future predictions.

2. is a short term calculation and doesn’t consider money made after payback period

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15
Q

Average rate of return calculation

A
  1. add positive cashflows
  2. takeaway initial cost of investment
  3. divide by the lifespan
  4. calculate as a percentage of investment
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16
Q

ARR definition

A

calculates the rate of return as a percentage of the investment

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17
Q

negatives ARR

A
  1. doesn’t consider the future value of cash
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18
Q

How to calculate net present value.

A
  1. multiply each return by discount factor
  2. add all values up
  3. minus the cost of investment
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19
Q

evaluation of investment appraisals

A
  1. the validity of the predictions (without past experience it may be biased)
  2. doesn’t account for external shocks
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20
Q

what does theory suggest if the NPV is positive

A

the theory suggests that a business should go through with the project

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21
Q

how to calculate contribution per unit

A

selling price- variable cost per unit

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22
Q

break even calculation

A

fixed cost/ contribution per unit

23
Q

what is break even

A

the level of output needed for a firm to cover its costs

24
Q

limitations of breakeven

A
  1. assumes all stock is sold at the same price
  2. doesn’t take into account the future value of money
  3. variable costs are likely to change (COVID)
25
Q

how to calculate variance

A

actual- budgeted

26
Q

what is a favourable variance

A

when the differences in figures results in a positive outcome for the business.
EG when there are high revenues/lower costs than expected

27
Q

What the ideal for a current ratio

A

1.5:1

or 2:1

28
Q

Whats the ideal for acid test ratio

A

1:1

29
Q

what’s the suggested gearing ratio when interest is low

A

25%. Firms can afford to have higher gearing ratios as borrowing is cheaper

30
Q

what does the current ratio and acid test ratio actually calculate

A

whether a firm has sufficient short-term assets to cover its immediate liabilities.

31
Q

how to calculate capacity utilisation

A

(actual output/potential output) X100

32
Q

what’s the ideal capacity utilisation rate

A

theory suggests its 85%

33
Q

Contribution calculation

A

revenue- total variable costs

34
Q

Contribution per unit calculation

A

selling price -variable costs per unit

35
Q

Profit calculation using contribution

A

Profit= total contribution-fixed costs

36
Q

3 Breakeven advantage

A
  1. can help decide if the business is viable
  2. calculations are quick and easy
  3. can support loans and application
  4. may be motivational
37
Q

Margin of safety

A

difference in business actual output and its breakeven output

38
Q

what is an adverse variance

A

when the differences in figures results in negative outcome for the business.
EG when there are lower revenues/higher costs than expected

39
Q

why does a business do variance analysis

A

to make budgets more accurate in the future.

40
Q

Gross profit

A

Revenue-cost of sales

41
Q

Operations profit

A

Gross profit- operating costs

42
Q

Profit before tax

A

operations profit- interest

43
Q

evauluation of using a calculation

A
  1. it is only useful if compared with another thing such as competitors/ past years
  2. depends on how reliable the data is
44
Q

what is contribution

A

It focuses on the returns (contribution) a business makes from each unit of product sold and whether that return is enough to allow the business to make money overall after taking account of its fixed costs.

45
Q

what is a high gearing ratio

A

theory suggests 50% or above an organisation is highly geared

46
Q

what is a low gearing ratio

A

theory suggests 24% or below an organisation is lowly geared

47
Q

what is a mid gearing ratio

A

theory suggests 25-50% an organisation is moderately geared

48
Q

negatives of operations that are highly geared

A
  1. vulnerable to changes in interest (which is particularly likely as interest rates are rising in the UK to prevent inflation)

however this assumes that the business is on variable interest rates

49
Q

benefits of operations that are highly geared

A
  1. can access greater sources of finance
  2. they are less reliant on retained profit for growth and as a result may be able to award greater dividends to shareholders and investment may increase in the long term as a result
50
Q

negatives to being lowly geared

A
  1. the business may have to use retained profits to finance growth.

this may mean shareholders get less dividends and short term investors may see this as less profitable and stop investing as a result

51
Q

what may negatively impact the validity of the ROCE

A
  1. eg if a business sells a factory their ROCE may be higher than normal and it may give the business a false indication of performance
  2. if a firm leases a product there capital employed may be lower as it is cheaper and it may give a false indication of performance
52
Q

problems with having high liquidity ratios

A
  1. less money used to invest

2. less money to give to shareholders

53
Q

ways to improve liquidity

A
  1. reduce credit period offered to consumers
  2. delay payments to suppliers
  3. increase long term borrowing (however banks may be unwilling to offer loans to cover short term liabilities as it is risky)

Application (6 decks)

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