Ratios Flashcards
Name the purpose of ratio analysis
- ratios help compare current performance with previous records
- help compare a firm’s performance with similar competitors
- help monitor and identify issues that can be highlighted and resolved
- help with future decision making
How should ratios be calculated?
By using year-end balances where appropriate, unless the question specifies the use of average figures
Calculations should be shown correctly to two decimal places
Explain the term profitability ratios
Ratios that measure the ability of a business to generate profit
Explain and analyze mark up
When the gross profit is calculated as a percentage of the cost price. It measures the ability of the business to control the cost of inventory.
Calculation: Gross profit/ cost of sales x 100
Analysis: higher % is preferred as it indicates the better control of the cost of inventory
Explain and analyze gross margin
When the gross profit is calculated as a % of the selling price. Shows the gross profit earned on every portion of sales.
Calculation: gross profit/ revenue x 100
Analysis: higher % is preferred as it leaves sufficient gross profit to cover other operating expenses
Explain and analyze profit margin
When profit for the year is calculated as a % of revenue. Shows the profit earned from every sale
Calculation: profit for the year/ revenue x 100
Analysis: shows how well a business controls its expenses and also indicates the ability of the business to generate further income
Explain and analyze expense to revenue
When expense is calculated as a % of revenue
Calculation: expenses/ revenue x 100
Analysis: helps define the business’ financial health and its ability to scale operations up or down. The smaller the ratio, the better the chances are that the company has to generate profits, even if the revenues go down
Explain and analyze operating expenses to revenue
When operating expense is calculated as a % of revenue. In real estate, the operating expense ratio (OER) is a measurement of the cost to operate a piece of property, compared to the income brought in by the property
Calculation: operating expenses/ revenue x 100
Analysis: OER is used for comparing expenses of similar properties. An investor should look for red flags, such as higher maintenance expenses, operating income, or utilities that may deter them from purchasing a specific property. The ideal OER is between 60% - 80% (although the lower it is, the better)
Explain and analyze return on capital employed
Name suggestions and recommendations for improving profitability
- look for cheaper suppliers
- raise selling price of a product
- look for means to reduce operating expenses
-negotiate trade discount with current suppliers
- initiate other income generating activities
Explain the term liquidity ratios
Measures the ability of a business to meet short term debts
Explain and analyze current ratio
Is done to check if the business is able to repay its short term debts
Calculation: current assets/ current liabilities
Analysis: acceptable norm is 2:1
Explain and analyze quick/ liquid/ acid test ratio
Name suggestions and recommendations for improving liquidity
-Increase current assets
-if ratio is too high you can sell non-current assets
-decrease current liabilities
Explain the term efficiency ratio
Used to measure how effective a business uses its assets and liabilities internally
Explain rate of inventory turnover
Explain and analyze trade receivables collection period
Explain and analyze trade payables payment period
Name the effects of transactions of working capital
Explain and analyze earnings per share (EPS)
Explain and analyze price earnings (PER)
Explain and analyze dividend per share (DPS)
Explain the importance of accounting ratios to owners
Explain the importance of accounting ratios to owners
Explain the importance of accounting ratios to managers
Explain the importance of accounting ratios to trade payables
Explain the importance of accounting ratios to trade receivables
Explain the importance of accounting ratios to banks
Explain the importance of accounting ratios to employees
Explain the importance of accounting ratios to potential investors
Identify and discuss the limitations of accounting ratios
