RATIOS Flashcards
RETURN ON ORDINARY SHAREHOLDER’S FUNDS; RETURN ON EQUITY
Compares the amount of profit for the period available to the owners with their average investment in the business
RETURN ON CAPITAL EMPLOYED
Measures business performance by expressing the relationship between operating profit and the average long-term capital investment.
Reveals the effectiveness with which funds are being used
OPERATING PROFIT MARGIN
Most appropriate measure of operational performance because financing decisions do not influence this measure
GROSS PROFIT MARGIN
the difference between sales revenue and the cost of sales
a measure of profitability in buying and selling goods or services (before any other expenses are considered)
AVERAGE INVENTORIES TURNOVER PERIOD
average period for which inventories are held before they are sold
AVERAGE SETTLEMENT PERIOD FOR TRADE RECEIVABLES
average time it takes for credit customers to pay the amount they owe (the use of an average may give a distorted representation)
AVERAGE SETTLEMENT PERIOD FOR TRADE PAYABLES
How long it takes to pay for goods and services
High levels can provide the business with a free source of financing, but may decrease faith in the company (decrease in goodwill)
SALES REVENUE TO CAPITAL EMPLOYED
examines how effectively the assets of the business are being used to generate sales revenue
too high may indicate the business is over trading an asset
SALES REVENUE PER EMPLOYEE
measures the productivity of the workforce
What does the cash conversion cycle tell us?
the overall return on funds employed within the business will be determined both by the profitability of sales and by efficiency in the use of capital
CURRENT RATIO
v
ACID-TEST / QUICK RATIO
current: comparing liquid assets to current liabilities (higher number, more liquid business)
quick: more stringent test of liquidity because inventories cannot always be quickly converted to cash
CASH GENERATED FROM OPERATIONS TO MATURING OBLIGATIONS RATIO
(CASH RATIO)
Provides a view of the business’ ability to meet its maturing obligations (view of its liquidity)
GEARING RATIO
debt:equity
measures the contribution of long-term lenders to the long-term capital structure of the business (how geared the business is)
INTEREST COVER RATIO
(TIMES-INTEREST-EARNED)
measuring the amount of operating profit available to cover interest payable
the lower the ratio,the greater the risk to lenders that interest payments will not be met
DEBT RATIO
measures ability to pay all liabilities (lower is safer)
red flags in financial statements
earnings problems
decreased cash flow
too much debt
inability to collect receivables
buildup of inventories
downward facing trends of sales, inventory and receivables
overtrading
occurs when a business is operating at a level that cannot be sustained by the amount of finance that has been committed (causing liquidity problems)
- (often with young expanding businesses) managers did not anticipate the rapid increase in demand
- inflation causes more finance to be committed to inventories without an expansion of trade volumes
limitations of ratio analysis
ratios inherit the limitations of financial statements (cannot include all resources, manipulation)
can only give a snapshot, and not a complete understanding
the reported value of assets do not always reflect their current value; inflation can cause expenses to mismatch the price at the time of sale
