Ratios Flashcards
what is the purpose of ratio analysis?
- a calculation used to measure the performance of an organisation
- often used by investors both current and potential
- results can be conspired with the business’s past performance or with competition
- can be used to highlight areas where actions need to be taken in terms of financial positions
what are the three types of ratios?
- profitability ratios (3)
- liquidity ratios (2)
- efficiency ratios (1)
what are the three types of ratios?
- gross profit %
- profit of the year %
- return on equity employed %
what does profitability ratio measure?
how profitability and organisation is. usually used to analyse expenses, cost of inventory and the selling price
what are the two types of liquidity ratios?
- current ratio
- acid test ratio
what does liquidity ratio measure?
how able the business is to pay off short term debts and would highlight if a business sneered to arrange additionally finance to cover bills
what is the type of efficiency ratio?
-rate of inventory turnover
what is efficiency ratio?
measures how well the equity invested is being used
what is gross profit %?
- shows the profit made from buying and selling stock
- the higher the percentage the better
- shows how much gross profit is generate from everyone £1 of sales
what may have occurred for gross profit percentage increased?
- selling price may have be raised
- costs have been leered because cheaper supplier used
- increase in marketing activities - increase in demand
what may have occurred if gross profit percentage has decreased?
- costs have increased - cheaper suppliers should be located
- less marketing activities carried out may lead to less demand
- release of new profits form competitors therefore fewer sales
what is profit of the year %?
- used to measure the % of the rod it after expenses are deducted
- a low % means that expenses are too high and need to be controlled
- shows how much bent profit has been generated from every £1 of sales
if there’s an increase of profit of year this may be due to?
- gross profit has been higher
- expenses have been lower - cheaper alternative supplier have been located
if there is a decrease in profit of the year this may be due to?
- gross profit decrease
- expenses increase
what is return on equity employed %?
- shows investors what percentage return they would receive if they invested in the business
- they will want to see a high percentage further before investing
- a low % indicated that the business is making poor use of its capital resources
if there’s an increase in equity employed % that may mean?
- sales have increased - higher selling price and more marketing activities
- lower expenses
if there is a decrease in equity employed % that may mean?
- sales have decreased - less marketing activities or new competitors products
- expenses have been higher
what is current ratio?
- shows how able an organisation is to pay its short term debts. it would help a business to indicate whether they need additional finance to pay debts.
- an ideal ratio is 2:1 as this would mean that the business has double the amount of current assets compared to current liabilities - quite a stable financial position
- if it was any less the business may struggle to pay short term debts and the business needs to decrease it liabilities by then paying off creditors
- any higher than the business should ensure resources are not tied up and are used in the most effective way
increase in current ratio may mean?
- current liabilities have decreased - fewer creditors
- current assets have increased - more stock or money in the bank
decrease in current ratio may mean?
- current liabilities have increased -more creditors
- current assets have decreased-less stock or money in the bank
what is acid test ratio?
- shows how able an organisation to pay off its debts without having to sell stock.
- a ratio 1:1 is acceptable as this figures indicates the business can cover short term debts without relying on sale of stock
if there is an increase in acid test ratio this may mean?
- current liability have decreased
- current assets have increase
if there is an decrease in acid test ratio this may mean?
- current liabilities have increased
- current assets have decreased
what is rate of inventory turnover?
- measure the number of times inventory and to be replaced within a year
- a high figure means mass inventory sold rapidly
- a low figure means that the business needs to investigate ways of increasing sales
if there is an increase in rate of inventory turnover?
- increase in level of sales
- keeping up to date with customers wants and needs
if there is a decrease in the rate of inventory turnover?
- decrease in level of sales
- less marketing activities so there are fewer sales
what are the benefits of ratio analysis?
- good for comparing similar companies of similar size
- good for making comparison trends over a period of years
- ratios help to highlight and monitor issues need to be received
- if ratios are attractive - they can convince investors in the business
what are the limitation of ratio analysis?
- figures are historic and do not show the future
- business are difficult to compared because ether need to be exactly the same size and type
- external factors are not taken into consideration
- results do not show staff motivate or morale
- new product development or launches are not taken into consideration
what is gross profit calculation?
GP divided by sales x 100
what is profit of the year calculation?
NP divided by sales x100
what is return on equity employed calculation?
NP divided by equity employed x100
what is current ratio calculation?
current assets divided by current liabilities :1
what is acid test ratio calculation?
current assets - inventory divided by current liabilities :1
what is rate of inventory turnover calculation?
cost of sales divided by average inventory = times
