Unit 7.2-Financial Analysis Flashcards
Return on capital employed
Operating profit/TE+NCL
How efficiently capital is being used-MONEY MADE/MONEY PUT IN
Gearing
Proportion funded through long term loans etc. NCL/TE+NCL
Current ratio
Business’ ability to pay short term liabilities using short term assets.
CA/CL
Payables
How long on average it takes to pay back suppliers. Payables/Cost of Goods x365
Receivable days
How long on average customers take to pay on credit. Receivables/Revenue x365
Inventory turnover
Cost of goods/Average inventory held
Factors to consider about gearing 4
Interest rates
Type of company (limited)
Profitability of a business
Shareholders
Pros cons of loans
\+instant money \+no dilution \+cheap if interest rates low \+no shareholders to hold meetings \+lender has no claim on future profits -interest
Pros cons of shares
+less repayment pressure than loans, only pay if able to
+shareholders can give advice
-dividends
-risk of loss of control dilution
Use of financial ratios
Spot trends, strengths and weaknesses
Potential investors can use for analysis
Compare with competition
What does low GPM suggest
Cost of goods is high. Either cut costs or increase price
What does low OPM suggest and eval
Operating expenses high, so either cut costs in other areas, or lower fixed costs.
However, OP may be low due to big investments
Liquidity ratios
Show how much money is available to pay debt
What is considered a low current ratio, and what are the implications of a high one
Below 1.5=low suggests liquidity problems
High-too much working capital tied up in assets
Evaluation of current ratio
Different firms have different requirements for holding assets
Consider competitions ratio
Gearing-interest rates
High gearing-more affected by interest rates rise
Gearing-risk
High gearing-greater risk as more interest paid, less profits and dividends
Reason for low geared
Can cope with fall in profit, as can just reduce dividends, unlike loan repayments which have to be paid
Reason for high gearing
Fund growth
Maintain ownership
When is high gearing good (2)
In growth phase-profits high so can pay off loan (strong cash flow)
Low interest rates
ROCE Importance
If higher than interest rate-better than putting in bank
How to improve ROCE
Reduce NCL or increasing OP
Benefit of low gearing
Less risk of interest defaulting debt
Inventory turnover evaluation (4)
Doesn’t reflect seasonal fluctuations
Holding inventory can improve customer service i.e meet orders
Working capital can be lost if too much
Irrelevant to service firms
Limitations of financial ratios (3)
Doesn’t show internal strengths e.g quality of staff
Doesn’t show external factors e.g in a recession its expected for declining figures
Does not predict future as PESTLE, only past figures
Pros of financial ratios (2)
Inform decision making, identify financial strengths/weakenesses e.g if payables is low
Good measure of performance+for investors e.g high geared=risky. and comparable to competitors
