Topic 2: Interpreting Accounts Flashcards
Define profit quality
Is the degree to which profit is likely to continue into the future
Define extraordinary item
Significant transactions or events that are unusual and infrequent which are outside management’s control
What are the 5 types of financial ratios?
Investment Profitability Efficiency Liquidity Financial gearing
What can ratios be compared with?
Past periods
Similar businesses
Planned performance
What are the equations for profitability ratios?
Return on Capital Employed (ROCE):
100 x Operating profit/(Share Capital + Reserves + NCL)
Gross Profit Margin:
100 x Gross Profit/Sale revenue
Operating/Net Profit Margin: 100 x (Operating/Net profit)/Sale revenue
What to remember when calculating ratios?
Treat all numbers in the accounts as positive figure/number.
What are the equations for efficiency ratios?
Inventories Turnover Period in Days:
365 x Inventories/Cost of Sales
Settlement Period of Receivables (days):
365 x Trade receivables/Sales revenue
Settlement period for payables (days):
365 x Trade payables/Cost of sale
What are the equations for liquidity ratios?
Current Ratio:
Current assets/Current liabilities
Acid Test Ratio: Current assets (excluding inventories)/Current liabilities
What are the equations for gearing ratios?
Gearing Ratio:
100 x Long-term (NC)L/Capital employedie.SC+R+LTNCL
Interest Cover:
Operating profit/interest payable
Define the 5 financial ratios
Liquidity ratio: Determine a debtor’s ability to pay off current debt obligations without raising external capital.
Financial gearing: Compares some form of owner’s equity (or capital) to debt, or funds borrowed by the company.
Efficiency ratio: measures a company’s ability to use its assets to generate income.
Investment ratio: Is the ratio of an insurance company’s net investment income to its earned premiums.
Profitability ratio: A company’s ability to earn profits from its sales or operations, balance sheet assets, or shareholders’ equity.
What are the equations for investment ratios?
Dividend Yield Ratio:
Dividend per share/Market value per share
Earnings Per Share:
Earnings available to ordinary shareholders/No. of ordinary shares in issue
Price/Earnings Ratio (P/E):
Market value per share/Earnings per share
What are some of the limitations of ratio analysis?
Quality of financial statements - are inherently out of date Inflation Over reliance on ratios The basis for comparison SoFPs
Define inflation
Is the decreasing value of money
