Topic 2: Interpreting Accounts Flashcards

1
Q

Define profit quality

A

Is the degree to which profit is likely to continue into the future

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2
Q

Define extraordinary item

A

Significant transactions or events that are unusual and infrequent which are outside management’s control

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3
Q

What are the 5 types of financial ratios?

A
Investment
Profitability
Efficiency
Liquidity
Financial gearing
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4
Q

What can ratios be compared with?

A

Past periods
Similar businesses
Planned performance

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5
Q

What are the equations for profitability ratios?

A

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
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6
Q

What to remember when calculating ratios?

A

Treat all numbers in the accounts as positive figure/number.

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7
Q

What are the equations for efficiency ratios?

A

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

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8
Q

What are the equations for liquidity ratios?

A

Current Ratio:
Current assets/Current liabilities

Acid Test Ratio:
Current assets (excluding inventories)/Current liabilities
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9
Q

What are the equations for gearing ratios?

A

Gearing Ratio:
100 x Long-term (NC)L/Capital employedie.SC+R+LTNCL

Interest Cover:
Operating profit/interest payable

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10
Q

Define the 5 financial ratios

A

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.

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11
Q

What are the equations for investment ratios?

A

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

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12
Q

What are some of the limitations of ratio analysis?

A
Quality of financial statements - are inherently out of date
Inflation
Over reliance on ratios
The basis for comparison
SoFPs
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13
Q

Define inflation

A

Is the decreasing value of money

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