Theory- Ratio Reports Flashcards
Gross profit ratio
Gross profit/net sales
Indicates the number of cents in a dollar that represent gross profit in every dollar of sales. Good with a cogs account.
High ratio means an enterprise can cover its selling, administrative and financial costs. Earns acceptable profit, adequate return on investment.
Low ratio means a net loss may occur.
Net profit ratio
Net profit/net sales
Reveals the number of cents in a dollar that represents net profit in every dollar of sales. Reflect the managements ability to minimise expenses per dollar of sales. Net profit is sales revenue less all expenses. Indicated business success in profit terms. Low ratio means selling margin is very low, volume of sales is low when compared to fixed costs (coat don’t change when sale made).
Return of owners equity ratio
Net profit/ average owners equity
Indicates the return to the owner on the amount invested in the business. Profit is primary motive for owner investing in business, if cost outweigh the benefits results in investment not be undertaken. Compare with term deposit, and shares in other businesses. High- sound investment choice by owner, management efficiency, undercapitalised? Low- more beneficial for owner to invest elsewhere, cautiously run business. Return needs to be high for planned future growth, if net profit good but return bad may mean the business if overcapitalised.
Return of total assets ratio
Net profit+interest expense/ average total assets
Measures the effectiveness with which the business uses assets to generate revenue. Interest added as to not obscure results. High- good perforce of assets, affective use of assets to gain profit. May be distorted by heavily depreciated non-current assets, large amounts of intangible assets, unusual income of expense items. Make better by increasing net profit decreasing total assets
Turnover of inventories rate
Cogs/ av inventory
Measures how effectively the inventory of the business is being managed.
High- fast moving inventory, shortage of inventory. Effectiveness of new pricing or advertising campaigns. Effectiveness of just-in-time principle, sig difference between this and quick and current ratio means business relies on this for short term liquidity acceptable if most sales are cash.
Turnover of accounts receivable
Average accounts rec/net credit sales x 365
Indicates how quickly the average balance of acc r is being converted into cash through the year. How many days it’s takes. High-tight and effective credit policy. Low- in danger of bad debts. 10-15 days of stated policy. Consider with other liquidity ratios, bad debts being monitored carefully?
Current ratio
Current assets/current liabilities
Measures the ability of the business to meet is short-term financial obligations. Shows how many current assets the enterprise has to cover every dollar of liabilities. Rule of thumb is 2:1 but business can still work on lower ratio. High degree of assurance that Cl can be payed out of ca. Entity with high investment in inventories should have a higher ratio. Increase ca such as cash by increasing sales rev and monitoring expenses. Decrease current liabilities, short term loans to long term loans.
Quick ratio
Current assets-stock-prepayments/cl- overdraft
Business ability to meet immediate financial obligations, such as acc pay from easy access accounts assets such as cash and ar. Stricter than short-term liquidity. High degree of assurance that current liabilities can be paid out of current assets. Low- entity is dependant on inventory turn to pay current debts. 1:1 is good. Measure of short term liquidity proffered of current ratio due to fluctuation in inventories of businesses. Increase current assets by increase rev decrease exp. decrease current liabilities.
Debt ratio
Total l/total a
Indicates the way in which the business is financed and extent of firms borrowings. Is important to long term financial stBility. Indicates what percentage of assets ha pave been paid for with borrowings.
High-assets being funded from borrowings. Low-assets being funded by owners.
Durinfpg times of high interest rates better to have low debt as borrowed funds attract high interest payments. Debt neseccasry but must be balanced and managed well. 50-50 balance with equity is good. Debt ratio too high creditors may take action. Repay debts, minimise need to hold large sets
Equity ratio
Total owners equity/total a
Indicates the extent to which. The owner has financed the business. Relationship between goal owners equity and goal assets of the firm. Indicates what proportion of dollar of assets has been paid for by the owner. High-most funds provided by owner.
Cash flow to revenue ratio
Net cash from operating act/net revenue
Indicates the entities efficiency in converting revenue based on accrual sales and other revenue to cash. Indicates how efficiently the entity converts the actual revenue earned into cash from ops shown in cash flow statement. High- large proportion of rev is realised as cash. Should be similar to net profit ratio. For every dollar of sales and other rev, how much represents cash received from the ops of the business.
Financial reports
The function of financial reports is to communicate info to users in order to faciliTate the des icon making process.
Users of financial reports
Investors, lenders, suppliers, employees, customers, competitors.
Liquidity vs solvency
Liquid is the business ability to meet short-term financial obligations from current assets.
Solvency- entity’s having sufficient funds to meet long-term financial commitments
