Topic Four, Part 15 - Ratio Flashcards
What is ratio analysis?
comparing information contained in its financial statements
What areas can ratio analysis help with?
- Profitability
- liquidity
- shareholder return
What is liquidity?
The ability to convert assets into cash
What is current ratio?
Ratio between assets and liabilities to show level of liquidity within the business
What is the formula for current ratio?
current assets / current liabilities
What does a ratio of less than 1 mean when using the current ratio?
Firm cant pay its short term debts
What does a ratio of 1 mean when using the current ratio?
Firm can just pay its debts
What does a ratio of 1.5 - 2 mean when using the current ratio?
A good ratio, £1.50 - £2 of short-term assets for every £1 of short-term debt
What does a ratio of 3 mean when using the current ratio?
Firm has plenty of current assets - maybe too many
What is the acid test?
How many times a firm could pay its current liabilities using current assets, without selling stock
What do you calculate the acid test ratio?
current assets – inventories / current liabilities
What is the value of using ratios?
- Shareholders make decisions to invest
- measure performance
What is the limitations of using ratios?
- Inflation can distort figures
- Ratios can be calculated differently
- State of the economy
