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Business > 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

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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. (Residual/ 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

doesn’t consider the future value of cash
Ignores time
Focuses on profit rather than cash flow
Nit adjust for time-money

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18
Q

Net present value calculations

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

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23
Q

what is break even

A

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

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24
Q

limitations of breakeven

A
  1. assumes all stock is sold at the same price or one product
  2. doesn’t include bulk buying discounts
  3. variable costs are likely to change (COVID)
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25
Q

how to calculate variance

A

actual- budgeted

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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

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27
Q

What the ideal for a current ratio

A

1.5:1

or 2:1

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28
Q

Whats the ideal for acid test ratio

A

1:1

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29
Q

what’s the suggested gearing ratio when interest is low

A

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

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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.

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31
Q

how to calculate capacity utilisation

A

(actual output/potential output) X100

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32
Q

what’s the ideal capacity utilisation rate

A

theory suggests its 85%

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33
Q

Contribution calculation

A

revenue- variable costs

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34
Q

Contribution per unit calculation

A

selling price -variable costs per unit

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35
Q

Profit calculation using contribution

A

Profit= total contribution-fixed costs

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36
Q

Breakeven calculation

A

fixed costs/ contribution per unit

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37
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
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38
Q

Margin of safety

A

difference in business actual output and its breakeven output

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39
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

40
Q

why does a business do variance analysis

A

to make budgets more accurate in the future.

41
Q

Gross profit

A

Revenue-cost of sales

42
Q

Operations profit

A

Gross profit- operating costs

43
Q

Profit before tax

A

operations profit- interest

44
Q

Payback

A

Time to an investment pays itself back

45
Q

Payback benefits

A

Easy to calculate and understand the result

46
Q

Payback drawbacks

A

Ignores cash flows after payback has been reached
May encourage short term thinking
Takes no account of the time value if money
Does not consider profitability in payback

47
Q

Benefits of ARR

A

Simple understand and easy to calculate
Focuses on overall profitability of an investment
Easy to compare
Uses all returns generated by a project throughout

48
Q

Net present value

A

Calculates the present value of future income from an investment , minus the cost

49
Q

Purpose of budgets

A

Focus expenditures on company’s main objectives
No more is spent then the company expects
Measure of performance
Gives managers more responsibility - herzberg motivation

50
Q

Types of budget

A

Historical budget - based on previous budgets with adjustments such as inflation
Zero-based budgets - based on justification of a manager (time consuming)

51
Q

Variance analysis

A

Adverse - worse

Favourable - better

52
Q

Variance analysis managers

A

They can spot areas of significant variance through software such as excel

53
Q

Budget variances occur because…

A

Original budget was unrealistic
The target was not met due to factors beyond the budget-holders control
The target was not met due to to factors within the budget-holders control

54
Q

Difficulties of budgeting

A

Setting budgets - unrealistic targets but also avoid budgets creeping up

Agreeing or imposing budgets - imposing budgets is far less motivating and effective than giving than gibbing budget-holders a genuine say in setting targets, in agreement with senior managements

Failing to understand the causes of a budget variance - blaming budget holder is demotivating

The costs of the system outweighing the benefits - smaller businesses, single manager can keep control of finance without needing to set up budgets

55
Q

Ways to improve profit

A

Increase revenue/selling price
- increase profit margin but may decrease overall profit - PED + SALES VOLUME

Decrease costs

  • using cheaper materials or less labour can damage reputation therefore revenue
  • only when an obvious source of waste is produced that a straightforward cut in costs happens
56
Q

What document does all PLC have to produce to companies house

A

Statement of comprehensive income (balance sheet)

57
Q

Cash flow and profit

A

Sales revenue does not equal cash inflow

Costs do not equal cash outflows

58
Q

Improving liquidity

A

Selling under-used fixed assets such as equipment or machinery
Raising more share capital
Increasing long-term borrowing through loans
Postponing planned investments

59
Q

Managing working capital cycle

A

Ensuring there is enough cash in the cycle

Making sure it moves through the cycle as quickly as possible

60
Q

If capital cycle requirements are met then the following actions are likely to be used….

A

Control cash used
Minimise spending on fixed assets
Plan ahead for the next few months

61
Q

Under-utilisation of capacity utilisation

A

Lead to fears for job security among staff, damaging motivation
Poor morale among managers
Contribute to a poor reputation for the business - empty tables restaurants

62
Q

Over-utilisation of capacity

A

Unable to accept new orders, Turing away new customers to rivals
No time for maintenance on machines or train staff

63
Q

Improving capacity utilisation

A

Increase current output

Reduce maximum capacity

64
Q

Swot analysis approaches

A

Top-down approach - external consultants

Consultative approach - boss analyses whole business

65
Q

Top-down approach + -

A

+ a dispassionate approach
+ detachment from company culture may shed light on business
- managers may fail to share all necessary info about business

66
Q

Consultative approach + -

A

+ greater insight from a wider range of contributors
+ the chance for boss to gain first hand understanding of the whole business
- staff less likely to point out problems as it may reflect badly on them

67
Q

Key performance indicators

A 
Staff turnover 
Like-for-like sales
Market share 
Capacity utilisation 
Unit cost 
Brand recognition 
Staff turnover
68
Q

Opportunities and threats

A 
Demography - adaptation 
New laws and regulations 
Technological factors
Competition - porters five forces
Commodity prices - increase/decrease 
Economic factors - growth, inflation, tax, interest, unemployment and exchange rate
69
Q

What do large businesses do (SWOT)

A

Lobbying - persuading MP’s to make decisions in bets interests of the business

70
Q

PESTLE

A 
Political 
Economical
Social
Technological 
Legal
Environmental
71
Q

Political factors

A

Following Brexit

  • less access to EU market
  • import cost increase
  • devalued pound
  • less FDI
72
Q

Economic factors

A 
Inflation 
Growth 
Unemployment 
Taxation 
Exchange rate
Interest rate
73
Q

Social factors

A

Trends

  • eating healthy
  • change attitude to smoking
  • desire for convenience and service
  • ageing population
74
Q

Technological factors

A

New products
Lowered production costs
Changes can be a threat

75
Q

Legal factors

A

New laws change structure and operations

76
Q

Environmental factors

A

Pressure for ethical
Opportunity for USP
Adopting more efficient methods

77
Q

What to do about external influences

A

Make the most of favourable factors

Minimise impact of unfavourable factors

78
Q

Posters five forces

A 
Threat of new entrants 
Threat of substitutes 
Supplier power
Consumer power 
Rivalry between competition
79
Q

Intensity of comp is low

A 
High barriers to entry 
Few companies 
Booming market 
Branding high
No direct comp from abroad 
Little spare capacity
80
Q

Intensity of comp is high

A 
equal size 
Undifferentiated products
Slow market growth 
Low capacity utilisation 
Low barriers to entry 
Faces comp from overseas
81
Q

Threat of new entrants

A

Depends on barriers to entry within market

  • patents
  • branding
  • high costs to customers of switching supplier = gas and electricity
  • substational network infrastructure
82
Q

Changes in the buyer power of consumers

A

Sells it product to many individuals it is favourable
Sells its product to few large customers it is unfavourable - economies of scale
Merges unfavourable
More expensive products and complex more favourable to business

83
Q

Changes in the selling power of suppliers

A

Number of alternative suppliers
Uniqueness of suppliers product or service
Reliance on the business on technical support from their supplier

84
Q

Threat of substitutes

A

How convenient and close substitute is

85
Q

Five forces shape strategy

A

Adapt to changes

Help business decisions - wiser and more effective

86
Q

Quantitive sales forecasting helps

A

HR plan - no of employed
Cash flow forecasting - based on sales forecasting
Profit forecasts and budgets. - accurate sales forecast
Production planning - enough products and raw materials are available

87
Q

Forecasting techniques used

A

Moving averages
Extrapolation - carry on the trend
Correlation - scatter graph

88
Q

Limitations of quantitive force casting techniques

A

The future may not be the same as the past - external shocks/trends
The quality depends on the quality f the forecasters interpretations - pairing variables

89
Q

Types of ratio

A

Profitability - relationship of profit and revenue with capital
Liquid - meet short term debts
Gearing - long term finance comes from loans

90
Q

Reduce an unhealthily high gearing ratio

A

Issue more shares
Retain more profits
Repay some loans

91
Q

Gross profit margin improve and too low

A

Price up
Unit variable costs down

May not be enough gross profit to cover overheads

92
Q

Operating profits improve and too low

A

Boost gross profit margin
Cut overheads per £ of sales
Increase sales

May not be enough operating to reinvent into the business and so get growth

93
Q

Net profit improve and too low

A

Boost operating profit margins
cut corporation tax bill legally

Too low to pay acceptable dividends

94
Q

Boosting ROCE

A

Find a way to increase operating profit

Reduce capital e,played without damaging operating profit

95
Q

Limitations of ratio analysis

A

Limitations of ability to whole business story
Lack of detail within h financial accounts - stocks and receivables aren’t shown
If receivables figure is on balance sheet, will be misleading in the ratios
If stock is about to go out of fashion becoming worthless, current ratio will mislead
On profit and loss account, net profit cash be affected by one off payments such as selling property
Boosting net profit, improve the net margin for this year, might be a blip, misleading those who do not investigate further than the ratio

Business (8 decks)

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