Section 3.7 - Strategic Position Flashcards
Financial Ratio Analysis - Gross Profit Margin
> tells us how much gross profit (pence) the business gets for every £ they get in revenue (sales)
Calculation:
Gross profit / sales revenue x 100 = %
- if the % is going up it could be because the cost of buying raw materials etc is going down - found a cheaper supplier or buying in bulk so achieving purchasing economies of scale
AND/OR - the business has been able to increase its selling price
Financial Ratio Analysis - Operating Profit Margin
> tells us how much operating profit (pence) the business gets for every £ they get in revenue
Calculation:
Operating profit / sales revenue x 100 = %
If the revenue is going up it could be because:
- revenue is higher/gross profit is higher
- expenses have been reduced e.g. this year the business hasn’t spent as much on marketing
- staff were mad redundant last year, therefore wages are lower
- found a new delivery company which has reduced transportation costs
Financial ratio analysis- Return on capital employed (ROCE)
> tells us how much operating profit the money that has been invested has generated
E.g.
If the business has made an operating profit of £30,000 and had invested £300,000 in share sales and loans, it means the turn on capital employed is 10%
Calculation:
Operating profit / total equity + non current liabilities x 100 = %
- takes into account the total equity (money received by the business from selling shares) and the loans etc the business has taken out
- the % is the ‘return’ - e.g. if the business % is 5% it means that you can compare the ‘return’ you could get elsewhere e.g. the interest you would get from a financial institution
- the higher the % the more efficiently the business is using the money
- this ratio says that for every £ invested three have earned % (pence) in operating profit*
Financial ratio analysis - current ratio
> shows the amount of current assets the business has for every £ of current liabilities they have (money in the bank).
E.g.
2:1 means that for every £ of current liabilities the business has £2 in current assets - means they can pay them back and still have assets
Calculation:
Current assets / current liabilities = actual ratio (_:1)
- different types of business will have differs views on the level in that they think is acceptable
- ratio shows the liquidity position of the business and its ability to pay their current liabilities which could be called in very quickly e.g. payables (suppliers) could demand payment
Business which have a quick turnover of stock, paid for in cash will be happier with a much lower current ratio - e.g. supermarkets, as they know they will get cash in everyday and can therefore cover their liabilities more easily = 0.8:1 may be good to them
A jewellers which has to have a high stock level and may not sell much each day may want a 4.5:1 ratio to ensure they don’t get into liquidity problems.
Financial ratio analysis - Gearing Ratio
> tells us what % of all the money invested (total equity PLUS non current liabilities) has been borrowed.
Calculation:
Non current liabilities / total equity + non current liabilities x 100 = %
- if a business is highly geared it means that the business has borrowed a lot of money and will be negatively affected when interest rates go up as they will have to repay more in interest (possibly causing cash flow problems and reducing profit)
- a financial institution will be less inclined to lend money if the gearing ratio is high - plays many of your assets may be used as a security against loans, so you have nothing left to bargain with
Example:
If the answer is 70%, it means that for every £ invested in the business, 70 pence is from borrowed money
Financial ratio analysis - Payables Days
> result is the number of days it is taking to pay the money to the business owes
Calculation:
Payables / cost of sales x 365 = days
^^^
- If it has gone up from precious years, this could imply that the business may have liquidity problems and is also not being run as efficiently
- may be due to the business being able to negotiate longer credit terms with suppliers, this could mean that you will have a better cash flow situation - having additional info is essential.
Financial Ratio Analysis - Receivables days
> the result is the number of days it is taking to get money from customers etc who owe the business money
Calculation:
Receivables / revenue x 365 = days
^^^
- of it has gone up to could imply the business is not being run efficiently
- it could be because the business has had to offer longer credit terms to remain competitive, as their main competitors are offering longer - if other businesses do not give similar credit terms, customers will go elsewhere.
An increase in recital be days may mean the business will have cash flow problems (liquify problems) - may have to consider debt factoring to help them improve their current ratio/cash flow problems
Financial Ratio Analysis - inventory turnover
> how many times the business will sell its stock in the year
Calculation:
Cost of goods sold / average inventories held = number of times a year
- some business will need to have high stock levels in order to remain competitive to give suckers choice - a low inventory turnover
- other businesses will sell them many times which is necessary eg clothing shops - the trend nowadays is to have many ‘new lines’ every three weeks - high inventory turnover
