Ratios Flashcards
What are the 3 profitability ratios?
Return on capital employed (ROCE)
Net profit margin
Gross margin
What is the formula for return on capital employed?
(Profit for the year i.e. net profit / capital employed) x 100/1
What are the two ways that capital employed can be calculated?
Owner’s capital + Non-current liabilities
OR
Non-current assets + Net current assets i.e. current assets - current liabilities
What is the formula for the net profit margin?
(Net Profit / Sales) x 100/1
What does the net profit margin indicate?
How well a business controls its expenses.
How can the net profit margin be improved?
Increasing the gross margin
Controlling expenses
Increasing incomes
What are the 2 liquidity ratios?
Current ratio
Acid test / Quick ratio
What is the formula for current ratio?
current assets : current liabilities
Between what values should the current ratio be?
Between 1.5:1 and 2:1
What can a business that is short of working capital encounter?
Cannot meet liabilities when due
Experience difficulties obtaining further credit
Cannot take advantage of cash discounts
How can the current ratio be improved?
Introduce further capital
Obtain long term loans
Sell surplus non-current assets
Increase profit
Reduce drawings
What is the formula for the acid test / quick ratio?
(current assets - inventory) : current liabilities
Between what values should the acid test / quick ratio be?
Between 0.5:1 and 1:1
What does the acid test / quick ratio indicate?
Can the business settle its debt without selling the inventory
What is the formula for the rate of inventory turnover?
For days, it is:
Cost of sales / Average inventory (1/2 x (opening inv. + closing inv.))
For times, it is:
(Average inventory / Cost of sales) x 365/1
How can a lower rate of inventory turnover be caused?
Lower sales
Inventory over-purchased
Too high selling price
Falling demand
Business inefficiency
What is the formula for trade receivables turnover?
(trade receivables / credit sales) x 365/1
What does the trade receivables turnover indicate?
Indicates the average time your debtors take to pay you
How can the trade receivables turnover be improved?
Improving credit control policy
Offer cash discounts
Change interest on overdue accounts
Refuse further supplies until outstanding debt is paid
What is the formula for trade payables turnover?
(Trade payables / credit purchases) x 365/1
What does the trade payables turnover indicate?
Indicates the average time the business takes to settle the debt with creditors
What effects happen when the business is taking longer to pay its creditors?
Supplier refusing more credit
Loss of cash discounts
Damage to relationship
What are the 5 problems of inter-firm comparison?
Businesses may apply different accounting policies
Non-monetary items are not in the accounting records but are important
Different operating policies
Relates to one financial year only - not possible to see trends
Financial years may be on different dates
Who are the 7 users of accounting statements?
Owners - see the profitability and liquidity position of the business
Managers - access past performance and plan for the future
Bank manager - if business requires a loan/overdraft
Trade payables - if the business is in a position to pay back its debt
Potential buyers - if the business is successful
Government - correct amount of tax is being paid
Employees/ trade union - salary / wage negotiations
What are the 4 limitations of accounting statements?
Time factor - record of what happened in the past
Historic cost - can only record at actual cost price - difficult to compare as a result of inflation
Accounting policies - all businesses should apply prudence and consistency. There are several policies that could be different.
Money measurement - only rewards items that can be measured
