Ratios

Question 1

What is ratio analysis?

Answer 1

Comparing figures from financial statements using financial ratios.

Question 2

What equation should always be carried out when comparing financial statements from different time periods?

Answer 2

Percentage increase/decrease in sales

Question 3

List all the ratios and group them based on whether they measure:
1) Profitabilitiy
2) Liquidity
3) Efficiency
4) Other

Answer 3

1) Profitability ratios
Gross margin
Mark up
Net margin
ROCE/ROI

2) Liquidity ratios
Current ratio
Acid test ratio

3) Efficiency ratios
Stock turnover ratios: Times per year/Days per year
Debtors collection period
Creditors collection period

Question 4

What is gross profit?

Answer 4

Company’s sales minus the cost of sales. Sometimes measured per unit.

Question 5

What is net profit?

Answer 5

Company’s gross profit - expenses. Sometimes measured per unit.

Question 6

What is the gross margin ratio? What is the formula?

Answer 6

Measures a company’s gross profit compared to its sales.

(Gross profit)
—————- X (100)
(Sales)

Question 7

What is the mark up formula?

Answer 7

(Gross profit)
—————- X (100)
(Cost of sales)

Question 8

What is the net margin formula?

Answer 8

(Net profit)
—————- X (100)
(Sales)

Question 9

What is the return on capital employed/Return on investment ratio?
How can it vary?

Answer 9

Definition and use:

(Profit before tax)
————————- (X) 100
(Shareholders funds)

Question 10

What are stock turnover ratios?

Answer 10

They calculate:
1) How many times per year stock is rotated
2) How many days between stock rotation

Question 11

Give the formula for both stock turnover ratios.

Answer 11

1) No of times stock is rotated:

(Cost of sales)
—————– = No. of times per y/m
(Average Stock)

Average stock is calculated by
- adding Opening stock and closing stock of time period (usually year/month)
- dividing sum by 2

2) How many days between stock rotation:

(Gross profit)
—————- X (100) = No. of days
(Sales)

Question 12

What is the debtors collection period ratio?
What is the formula?

Answer 12

The average amount of time it takes for debtors to pay back their debts to the business: How quickly the business can convert it’s debtors into cash

(Debtors)
————— X (365)
(Credit sales)

Question 13

What is the creditors collection period?
What is the formula?

Answer 13

The average amount of time in days it takes for the business to pay it’s creditors

  (Creditors) -------------------------   X (365) (Credit purchases)

Question 14

What is the current ratio?
What is it’s formula?

Answer 14

Definition and use: Measures a company’s ability to pay off its current liabilities (Short term liabilities) with its current assets (Cash or near cash). A ratio above 1:1 is considered sufficient, while a ratio between 1.5:1 and 3:1 is considered good. A ratio below 1:1 is considered bad.

Formula:

Current liabilities

Question 15

What is the acid test ratio (Quick ratio)?
What is its formula?

Answer 15

Definition and use: A financial measure used to assess a company’s ability to pay off it’s current liabilities using it’s most liquid assets.

Formula:

Current liabilities

Question 16

What is the three step problem to assessing financial documents and giving advice?

Answer 16

Step 1: Identify problems.
Use ratios to identify problems. Usually problems with
A) Profitability
B) Liquidity
C) Solvency

Step 2
Identify causes

Step 3
Give possible solutions

Question 17

Give possible solutions to profitability problems

Question 18

Give possible solutions to liquidity problems