Ratios Flashcards
What do we use ratios to measure?
Liquidity, Stability and profitability
What is liquidity
The ability of a business to pay its debts as they fall due
What is stability
The ability of a business to survive in the long term
What is profitability
The ability of a business to make an acceptable level of profit.
What are current ratios
Current Ratios ( the measure of the ability of a business to pay its short-term debts, that is debts payable in 12 months or less)
Current Ratios Formula
Current Assets / Current liabilities x 100
Meaning when CR is < 100%
Indicates either that a business may find it difficult to pay its short-term debts or that the business is operating in an industry in which money is collected from sales very quickly
Meaning when CR is beween 100% and 200%
Indicates that a business should be able to pay its short-term debts
Meaning when CR is >100%
Indicates that a business should be able to pay its short-term debts and that the business has extra current assets available (wasted) excess
Quick Asset Ratio
A measure of the ability of a business to pay its more urgently repayable current liabilities using ONLY its more liquid current assets.
Quick Asset formula
Current assets except for inventory and prepaid expenses/ Current liabilities except for bank overdraft x 100
Quick Asset > 100%
Indicates that a business should be able to pay its short-term debts.
Quick Asset <100%
Indicates that in an emergency, a business may not be able to pay its short-term debts
What is Gearing?
Term used to describe the extent of the borrowings of a business.
-A highly geared business has large interest and loan repayments and has an increased risk of failure
Debit to Equity Ratio
Measures the gearing of a business
Debit to Equity Ratio formula
Total liabilities/ Equity x 100
Debit to equiy ratio interpretation
- No acceptable figure for the debt-to-equity ratio.
- Small business may need to have a debt-to-equity ratio of about 70% or less.
- larger business may successfully operate with a debt-to-equity ratio of 100% to 200% or even higher
Profitability Ratio measuring
Four ratios that can be used as a measure of profitability are:
- Gross profit ratio
- Profit ratio
- Expense ratio
- Return on asset
Gross Profit ratio
Shows the percentage of gross profit that is contained in each dollar of sales
Gross Profit formula
Gross Profit / Net sales x 100
An increase in this year’s gross profit could be caused by?
a) Increase in selling price of the inventory greater than any increase in purchase price of the inventory
b) Purchasing of inventory at a low price
A decrease in this year’s gross profit could be caused by?
1) A decrease in the selling price of the inventory due to:
a) New competitors entering the market
b) A price war between competing businesses
c) A plan to increase market share by selling inventory at a cheaper price
2) An increase in the purchase price of the inventory greater than any increase in the selling price of the inventory.
Profit Ratio
The profit ratio shows the percentage of profit in each dollar of sales.
Profit Ratio Formula
Profit / sales x 100
Meaning of Profit ratio
Increase = Increase in the gross profit ratio or a reduction in expenses
Decrease = expense increases that are not being fully passed on to consumers in the form of increased selling prices or increased competition causing the business to lower its selling prices.
Expense ratio
The expense ratio compares the sales of a business to the total of the selling and distribution, general and administration, and financial expenses.
Expense ratio formula
Expenses( other than COS) / Net Sales x 100
Return ratio
The return on assets measures how efficiently a business uses its assets to generate a profit
Return ratio Formula
Profit / Average Assets x 100
