Unit 7 Ratio Analysis

Question 1

What is depreciation?

Answer 1

The reduction of the value of an asset over a period of time

Question 2

Why do firms depreciate assets?

Answer 2

• Poor/inadequate care means repairs are needed which reduces costs
• equipment looses value due to wear a tear

Question 3

What is working capital?

Answer 3

Measures the extent to which money is available to a business to be able to pay day to day expenses e.g bills and wages

Question 4

What would working capital be under on a balance sheet and how would it be calculated?

Answer 4

• Can be labelled as net current assets

= current assets-current liabilities

Question 5

What factors influence the amount of WC a firm needs to hold?

Answer 5

Volume of sales- if high more raw materials and wages are needed so more working capital is needed
Firms growth
The longer the operating cycle the more Working capital needed

Question 6

What are the four types of ratio?

Answer 6

Gearing,profitability,efficinecy & liquidity

Question 7

What are the sources of info for ratio analysis?

Answer 7

1) Published accounts
2) Norms/benchmarks from industry
3) Performance based on businesses performance over previous years
4) The economic environment

Question 8

What is the purpose of a liquidity ratio?

Answer 8

Allows mangers to monitor a businesses cash portion as it measures the liquid assets held by a business
-these are then compared with short term debts/liabilities a business may face to see if they will experience liquidity problems

Question 9

What is the ratio used for liquidity and how is it calculated?

Answer 9

Current ratio = current assets ÷ current liabilities

Question 10

Whats the typical current ratio figure and how can a business improve theres?

Answer 10

1. 6:1

- Raising more through sale of non current assets

Question 11

What would a current ratio of 2:1 mean?

Answer 11

This means a firm possesses £2 of current assests for each £1 of current liabilities meaning in this case they would meet its current liabilities

Question 12

What is the purpose of a profitability ratio and what are three types of profit margins?

Answer 12

Purpose is to compare a businesses level of profits to another factor such as amount of revenue

1) Gross profit margin
2) Operating profit margin
3) Profit for the year margin

Question 13

What is a profit margin?

Answer 13

A ratio expressing a businesses profit as a % of its revenue of a trading period

Question 14

What the ration used in profitability ratios and how is it calculated?

Answer 14

Return on capital employed - Compares the operating profit earned with the amount of capital employed

= Operating profit x100 ÷ total equity + non current liabilities

Question 15

What us the typical ROCE and how can it be improved?

Answer 15

20-30%

- Can be improved by reducing the capital employed or repaying some long term borrowing

Question 16

What is the efficiency ratio?

Answer 16

A group of ratios that measure the effectiveness to which management controls internal operations in a business.g time taken for business to settle debts

Question 17

What three ratios are used for efficiency?

Answer 17

1)Inventory turnover - Measure the companies success by converting inventories into sales

2) Receivable days - The time taken for a business to collect the money its owed
3) Payable days - Calculates the time typically taken for a business to pay the money its owes to suppliers

Question 18

What is the calculation of Inventory turnover that shows the number of days taken on average to sell inventories?

Answer 18

inventories x365 ÷ cost of sales

Question 19

What is gearing and how is it measured?

Answer 19

The extent to which a businesses money comes from borrowing in the long term
= Non current liabilities x100 ÷ total equity + non current liabilities

Question 20

What is the % associated with being a highly and low geared business?

Answer 20

low - anything less than 50%

high - anything more than 50%

Question 21

How do u calculate capital employed?

Answer 21

non current liabilities + total equity

Question 22

What sources of information are required for ratio analysis?

Answer 22

1) The performance of the business over recent years - assists in making judgements
2) Norms/benchmarks for the industry - results of ratio calculations should be judged against what is normal for the industry
3) Economic environment

Question 23

How do you calculate inventory turnover?

Answer 23

cost of goods sold ÷ average inventories held

Question 24

How do you calculate receivable days?

Answer 24

receivables x365÷ revenue

Question 25

How do you calculate payable days?

Answer 25

payablesx365 ÷ cost of sales

Question 26

What is meant by high quality profit?

Answer 26

This is profit that is likely to continue into the future as high quality profit e.g introducing a product that immediately generates a surplus and looks to have a promising future will be high quality profit.