Ratios Flashcards
What are the four main categories of ratios?
- Profitability
- Liquidity
- Use of resources
- Financial position
What is the ratio for return on capital employed (ROCE), and what does it measure?
Profit from operations
———————————– x100
Capital Employed
Where Capital employed = total equity + non-current liabilities = total assets - current liabilities
This is a profitability ratio. It measures how successfully a business used the funding it has received.
A low return on capital employed is caused by either a low profit margin or a low asset turnover or both.
What is the ratio for return on shareholder’s funds, and what does it measure?
Profit after tax
———————- x100
total equity
This is a profitability ratio. It measures the return earned for ordinary shareholders.
We use the profit after preference dividends and interest. (ie the amounts that have to be paid before ordinary shareholders can be rewarded)
This ratio helps to assess the value of shareholders investments and if their money would be better invested in other companies or in the bank.
A better percentage is usually due to a higher profit or lower equity.
What is the ratio for gross profit percentage and what does it measure?
Gross profit
——————- x100
revenue
This is a profitability ratio. It focuses on the trading account. A low margin could indicate selling prices are too low or cost of sales is too high. If there are dramatic changes it would indicate the need for further questions to assess any market or company changes.
What is the ratio for operating profit and what does it measure?
What does a low margin indicate?
Profit from operations
———————————- x100
revenue
This is a profitability ratio. It measures the profit from operations expressed as a percentage of revenue. A low margin indicates low selling prices or high costs or both.
What is the ratio for expenses/revenues percentage and what does it measure?
What could a worse percentage indicate?
Admin or Distribution expenses
———————————————— x100
revenue
This is a profitability ratio. If there are dramatic changes to the operating profit percentage you could choose a specific expense in relation to revenue to compare.
A worse percentage could be due to unexpected cost increases or due to worse controlled costs.
What is the current ratio and what does it measure?
What does a better ratio mean
Current Assets
————————– = ‘X’:1
Current Liabilities
This is a liquidity ratio. It is a common method of analysing working capital and is generally accepted as a good measure of short term solvency. It indicates the extent to which the claims of short term payables are covered by assets that are expected to be converted to cash.
A better ratio means that there are enough liquid resources to meet obligations.
What is the quick ratio (or Acid test) and what does it measure?
Current Assets - Inventory
————————————— =’X’:1
Current Liabilities
This is a liquidity ratio. It tests the solvency of a business as it concentrates on the current assets that are more readily available to be converted to cash.
What is the interest cover ratio and what does it measure?
Profit from operations
———————————– =’X’ times
Finance costs
This is a financial position ratio. This compares available profit with the amount of interest to be paid.
Interest on debt has to be paid before shareholders can receive dividends.
What is the gearing ratio and what does it measure?
Gearing is how much the company relies on borrowing
What would a higher percentage mean?
Total debt
——————————— x100%
total debt + equity
where total debt = non-current liabilities only
This is a financial position ratio.It gives a indication of long term liquidity and the financial fisk inherent within the business.
A lower percentage means the liquidity has been well managed, and it will be able to borrow more easily in the future. It is also unlikely to have just invested heavily in non-current assets.
What is the inventory turnover ratio and what does it measure?
Cost of sales
——————– =’X’ times
inventory
This is a use of resources ratio. It shows how many times per year the turnover is sold. It can fluctuate heavily for seasonal businesses.
What is the inventory holding period (days) ratio and what does it measure?
What does a lower amount of days mean?
Inventories
—————— x365
cost of sales
This is a use of resources ratio. A lower amount of days means stock is being sold faster and there is good stock control. It is also unlikely to have obsolete stock.
What is the trade receivables collection period ratio and what does it measure?
What does a long collection period indicate?
trade receivables
————————– x365
revenue
This is a use of resources ratio. It is an expression in days the length of time to collect money from credit customers.
A long collection period indicates poor credit control, that customers may be in breach of contract, or poor liquidity.
What is the trade payables payment period and what does it measure?
What are the issues with a low payables period, and with a long payables period?
trade payables
————————– x365
clst of sales
This is a use of resources ratio. It is an expression in days the length of time to pay credit suppliers.
A low payables period indicates the company may not be using best use of its cash by paying suppliers early. A long payables period means the business must be careful not to harm relations with suppliers, and that it may not be taking full advantage if settlement discounts.
What is the working capital cycle and what does it measure?
Inventory days + receivable days - payable days
The working capital cycle represents the time period between payment for inventory and receipt of cash from customers for the sale of goods and services.
A shorter working capital cycle is better.
