Topic 7.2 - Financial ratio analysis Flashcards
1
Q
Balance sheet
A
Shows what a business owns and owes on one day
2
Q
Income statement
A
Records all the business revenue and costs in a period of time
3
Q
Assessing financial performance using a balance sheet
A
- profit - compare with previous sheet
- see performance through reserves
4
Q
How to assess business performance through a income statement
A
- measure success compared with previous year
- actual performance to expectation
- gross profit, operating profit and net profit
5
Q
Current ratio analysis
A
- too high - too many resources tied up in unproductive assets
- too low - cannot pay debts
Alter ratio
- selling fixed assets
- raising share capital
- increase long term borrowing
- postponing planned investments
Evaluating
- good for inventory holding businesses
- less relevant for business with high stock turnover
- significant deterioration in ratio can indicate a liquidity problem
6
Q
Gearing
A
Highly geared
- has to pay substantial interest charges before dividends
- high risk
7
Q
Ways to manage gearing
A
Reduce
- focus on profit improvement
- repay long term loans
- retain profits
- issue more shares
- convert loans to equity
Increase
- focus on growth
- convert short term debt to long term loans
- buy back ordinary shares
- pay increased dividends from retained earning
- issue shares
8
Q
Benefits of high gearing
A
- less capital required to be invested by shareholders
- debt can be a cheap source of finance
- easy to pay of interest if profits and cash flow are strong
9
Q
Benefits of low gearing
A
- less risk of defaulting on debts
- shareholders rather than debtors in charge
- business has the capacity to add debt if required
10
Q
ROCE
A
High
- resources are being used efficiently
Compare
- against interest rates
11
Q
Inventory turnover interpretation
A
- evaluated with the industry you operate in
- changes from one year to the next
- fall may show slow moving or obsolete inventory
12
Q
Payable days interpretation
A
- higher figure is better for cash flow
- payable days should be higher than receivables
- high figure may suggest liquidity
- compare with current ratio
13
Q
Receivable days interpretation
A
- average time customer take to pay
- compare to norm
- changes
- compare with competitor
14
Q
Value of financial ratios when assessing performance
A
- only assess quantitative data
- if a business wants to succeed they will need to sacrifice profits
- affected by the state of the market
- analyse with other data over years
- analyse with competitors
- identify issues
- indicated business performance
15
Q
Limitations of ratio analysis
A
- one data set is not enough
- reliability of data
- based on the past
- comparability
- external environment changes all the time
Don’t tell you
- competitive advantage
- quality
- ethical reputation
- future prospects
- changes in external environments
