Unit 1/2- Topic 10: Ratio Analysis (✅)

Question 1

What are the advantages of Ratio Analysis?

Answer 1

1. Figures in financial statements are meaningless. Ratio analysis helps to provide meaning to the data.
2. It allows the business to analyse the current year’s performance.
3. Allows for comparison of results with competitors in the same industry.

Question 2

What are the disadvantages of Ratio analysis?

Answer 2

1. Results are based on historic data therefore not reliable to predict the future.
2. Difficult to compare two different businesses based on two figures alone. (E.g. different staff, equipment, financing, etc).
3. A business financial situation can change on a daily basis.
4. (Accounts- some businesses use different accounting techniques to calculate depreciation therefore it is difficult to compare two performances).

Question 3

How do you calculate Return on Capital Employed (ROCE)?

Answer 3

Net profit before interest
——————————————- X 100= %
Total assets - current liabilities

Question 4

How do you calculate Gross Profit Margin/ Percentage?

Answer 4

Gross Profit
———————- X 100= %
Sales Revenue

Question 5

How do you calculate Net Profit Margin?

Answer 5

Net Profit
———————- X 100= %
Sales Revenue

Question 6

How do you calculate the Current Ratio?

Answer 6

Current Assets
————————- = e.g. 2:1
Current Liabilities

Question 7

How do you calculate Gearing?

Answer 7

Non-current liabilities
——————————————- X 100= %
Total Equity + Non-Current Liabilities

Question 8

How do you calculate Earnings per share (EPS)?

Answer 8

Profit after tax
———————————- = EPS (e.g. 40p)
Number of ordinary shares

Question 9

How do you calculate the Return on Equity (ROE)?

Answer 9

Profit after tax
——————— X 100= %
Equity

Question 10

What is Return on Capital Employed (ROCE) used for?

Answer 10

Measures how effectively management is using the business’s capital.
“What % return will I get on my capital?”
The Higher The Better! (suggests that resources are being used efficiently).

Question 11

What is Gross Profit Margin used for?

Answer 11

Tells us what % of sales is gross profit.
Does not take expenses into account.
The Higher The Better!

Question 12

What is Net Profit Margin used for?

Answer 12

It measures the net profit as a percentage of sales/revenue.
The Higher The Better!

Question 13

What is Current Ratio used for?

Answer 13

Used to show the number of times current assets exceed current liabilities.
Ideal= 1.5:1/2:1 (efficient management)

Question 14

What is Gearing used for?

Answer 14

Shows the extent to which a business is dependent on borrowed money. (Measures the level of risk)
Above 50%= Highly Geared (high debt= more interest and less likely to lend)
Below 50%= Low Gearing (low debt)

Question 15

What is Earnings Per Share (EPS) used for?

Answer 15

-Measures the company’s earnings (profit after tax) divided by the number of ordinary shares it has issued.
-Shows the potential for paying out a dividend to shareholders but unlikely to pay all as some is reinvested.

Question 16

What is Return on Equity (ROE) used for?

Answer 16

This measures the ability of a business to generate profits from its shareholders’ investments.