unit 5: Chapter 32: Analysis of published account

Question 1

Gross profit margin (%)

Answer 1

• gross profit/ sale revenue x 100
• Uses to assess how successful the management a of a business has been at converting sale revenue into both gross and net profit -> Use to measure performance of business + management team.
• This ratio compared gross profit (profit b4 deduction of overhead) with sales turnover

Question 2

Explain gross profit margin (4)

Answer 2

1. The higher the better
2. Nếu thấp có thể do dùng low-price strategy to increase sales or higher cost of sales e.g) higher material costs of higher direct labour costs
3. Thấp = management is less effective in controlling costs
4. Good indicator of how effectively managers have added value to the cost of sale

Question 3

How to increase gross profit margin? (2)

Answer 3

1. Reducing costs of sales while maintaining revenue - dùng cheaper supplier
2. Increase revenue without increase cost of sales - tăng giá but offer better services

Question 4

Net Profit Margin (%) Net là lợi nhuận sau cùng, khi trừ hết opportunities cost

Answer 4

1. Net profit /sale revenue x100
2. Compared net profit (profit after all costs have been accounted for but b4 tax and interest have been deducted) with sales revenue
3. The higher the net profit margin, the better the company is doing at turning sales into profit.
4. Strong sales = increase the net profit margin; however, decreasing costs and overhead also help turn those sales into profit

Question 5

Define Profitability Ratio and what’s in it (2)

Answer 5

• Ratio that use to asses how successful the management of a business has been at earning profits for the business from sales and from capital employed - use to measure performance
• ROCE - Return of captial employed

Question 6

What is ROCE (1)

Answer 6

Return on capital employed (%) = net or operating profit / total employed x 100

Question 7

Define capital employed (1)

Answer 7

The total value of all long term finance invested in the business. It’s equal to (non current asset + current asset) - curren liability or non current liability + shareholder’ equity.

Question 8

Explain ROCE (4)

Answer 8

• The higher the value of this ratio = the greater the return on the capital invested in the business
• Can be compared with both other companies and the ROCE of previous year’s performance
• ROCE result should be compared with the interest cost of borrowing finance- if it’s less than this interest rate -> any increase in borrowing will reduce returns to shareholders
• ROCE is not related to the risk involved in the business. A high return may be the result of a successful undertaking with high risk rather than true business or managerial efficiency

Question 9

How to Increase ROCE? (1 - 3 and 2 - 1)

Answer 9

Increase operating profit without increaseing capital employed, e.g)

1. Raise price
2. Reduce vatiable costs per unit
3. Reduce overheads, such as delayering or reducing promotion cost

Increase operating profit that reduce capital employed

1. Sell assets that contribute nothing ot little to sales/profit- by use the capital raised to reduce debts

Question 10

Limitation of ROCE (5)

Answer 10

1. The method used for the calculation of captial employed is not universally agreed and this causes problems for comparisons between companies
2. Demand could be price elastic
3. Cheaper materials could cut back on quality
4. asset may be needed in the future e.g) for expansion of business
5. May not be effective in inreasing profit in the short term and may have drawack e.g) less promotion could reduce sales

Question 11

Liquidity Ratio (2)

Answer 11

1. Current ratio: = Current Assets/ Current liabilities. shows the rate the business affords to pay current liabilities out of their current assets.
2. Acid test ratio: = (Current Assets - Inventories) / Current liabilities.

Question 12

What is in financial efficiency ratio (2)

Answer 12

1. Inventory or stock turn over ratio
2. Day’s sales in receivables ratio

Question 13

Inventory (stock) turn over ratio (2)

Answer 13

Cost of good sold / value of inventories

• This ratio records the number of times the stock of a business is bought in and resold in a period of time

Question 14

Explain stock turn over ratio (4)

Answer 14

1. The number of times stock turn over in the time period - usually 1 year
2. The higher the number, the more efficient the managers are in selling stock rapidly e.g) Using JIT for stock management.
3. The higher the ratio, the lower the investment in stock will be
4. The result depends on the industry they are in
   
   1. eg) A bakery would have higher stock turn over than a car dealer.
5. For service-sector firm like insurance companies, this ratio doesn’t really matter because they’re not selling “products” held in stock.

Question 15

Days’ sales in recievable ratio, what’s it? (3)

Answer 15

1. Account receivable x 365/ sales turnover
2. Known as debtors’ collection period
3. Measure on how long, on average, it takes the business to recover payment from customers who have bought goods on credit - the debtor

Question 16

Explain days sales in revieable ratio

Answer 16

1. The shorter the time period, the better the management is at controlling its working capital.
2. A business selling almost exclusively for cash wil have a very low ratio result
3. A high days’ sales in recievables ratio may be a deliberate management strategy - customers will be attracted to business that give extended credit
4. Result that is higher than average could result from poor control of debtors and repayment period

Question 17

Note on days sales in recievable ratio (3)

Answer 17

• This ratio can be reduced in 2 ways:
  
  1. Shorter credit term: 30 days instead of 60
  2. Improving credit control
• Will involve refusing to offer credit terms to frequent late payers
• Can raise disagreement between departments. eg) marketing team wants to increase credit terms for customers to sell more, but the finance team wants all customers to pay for prudcts as soons as possible,

Question 18

What’s in the Investment ratio (shareholder ratio) (5)

Answer 18

1. Dividend yield ratio (%)
2. Dividend per share
3. Dividend cover ratio
4. Price Earning ratio (P/E ratio)
5. Gearing ratio

Question 19

Dividend yield ratio (%) (2)

Answer 19

• dividend per share x 100/ current share price
• This measure the rate of return a shareholder gets at the current share price

Question 20

Explain dividend yield ratio (%) (7)

Answer 20

1. If the share price rises perhaps due to improved prosects for the business, then with an unchanged dividend the dividend yield = fall
2. If the directors propose an increased dividend, but the share price does’nt change -> the dividend yeild = increase
3. For effective analysis, needs to be camplred with previous years+other companiesinsame industry
4. Potential shareholders might be attracted to buy shares in a company witha high dividend yield as long as share prices ko expected to fall in coming month
5. Directors may decide to pay dividend from reserves kể cả khi 0 có profit hoặc đang lỗ inorder to keep shareholders loytatty
6. Directors may decide to giảm the annual dividend kể cả khi profit ko giảm in order to increase retained profits - allows further investment into expanding the business
7. A high dividend yield may not indicate a wise investment - yield could be high because the share price gần đây bị giảm possibly vì the stock market is lo về long-term prospect của cty.

Question 21

Dividend cover ratio (3)

Answer 21

1. profit after tax and interest/ annual dividends
2. This is the number of times the ordanary share dividend could be paid out of current profits
3. The higher the ratio the more able the company is to pay the prosposed dividends -> leaving a considerable margin for reinvesting profits back into business

Question 22

Explain dividend cover ratio (2)

Answer 22

1. If directors decided to increase dividends to shareholders, with no increase in profits -> ratio would fall -> potential investor sẽ bắt đầu thắc mắc whether this level of dividend can be sustained in future
2. A low result = the directors are retaining low profits for future investment -> this could raise doubt abt company’s future expansion

Question 23

P/E ratio and earning per share (6)

Answer 23

1. Current share price / earning per share
2. Earning per share = profit after tax/ total number of share
3. PE is a vital ratio for shareholders and potential shareholders.
4. Reflect the confidence that investors have in the future prospects of the business
5. High PE ratio = investors are expecting higher earning growth in the future
6. Low PE ratio e.g) 1 = investor had little confidence in the future earning power of business

Question 24

Explain PE ratio (3)

Answer 24

• Ratio should only compared with other companies in same industry
• Not useful for investor using PE ratio as a basis for their investment decision
  
  • e.g) compare PE ratio của tech cty (có thể high PE) to a utility cty (có thể low PE) as each industry has different growth prospects
• The result shows how much investors are willing to pay for each $1 of earning
  
  • e.g) Nếu cty có PE = 20 => Investors are willing to pay $20 for 1$ of current earning.

Question 25

Gearing ratio (%) (4)

Answer 25

• `Long term loan/ capital employed x 100

or

• Non current liabilities x100 / share holder’s equity + non current liabilities
• This measure the degree to which the captial of the business is finaned from long-term loans
• The greater the reliance of a business on loan cpaital, the more highly geared it’s said to be

Question 26

Explain gearing ratio (6)

Answer 26

1. Cái ratio shows sự dựa vào của công ty on external long term borrowing to financed the company’s asset (nhiều là ko an toàn)
2. Result over 50% = highly geared = ko ổn
3. The higher the ratio = the greater the risk taken by shareholers khi đầu tư vào công ty, bởi vì:
   
   1. the higher the borrowing of cty, the more interest must be paid -> will affect the ability of cty to pay dividends and earn retained profits - the case when interest rate cao và profit thì thấp
   2. Vẫn phải giả interest - but from declining profit
4. Sẽ dẫn đến low liquidity khi cty vẫn phải giả debt cao so với capital
5. Low gearing ratio có thể là safe business strategy -> nhưng shows là manager ko chịu mượn tiền để expand or invest vào cty -> problems for shareholders if they want rapid and increase return on their investment .
6. Shareholders in a cty following a successful growth strategy financed by high debt will find their returns increasing much fasster than in a slower growth cty not take risks through high borrowing

Question 27

How to reduced gearing ratio (2)

Answer 27

• Using non profit loan source of finane to increase capital employed
  
  • e.g) Issuing more shares or retaining profits-> Increase shareholder’s funds and capital employed and lower gearing ratio