Unit 7.2-Financial Analysis

Question 1

Return on capital employed

Answer 1

Operating profit/TE+NCL

How efficiently capital is being used-MONEY MADE/MONEY PUT IN

Question 2

Gearing

Answer 2

Proportion funded through long term loans etc. NCL/TE+NCL

Question 3

Current ratio

Answer 3

Business’ ability to pay short term liabilities using short term assets.
CA/CL

Question 4

Payables

Answer 4

How long on average it takes to pay back suppliers. Payables/Cost of Goods x365

Question 5

Receivable days

Answer 5

How long on average customers take to pay on credit. Receivables/Revenue x365

Question 6

Inventory turnover

Answer 6

Cost of goods/Average inventory held

Question 7

Factors to consider about gearing 4

Answer 7

Interest rates
Type of company (limited)
Profitability of a business
Shareholders

Question 8

Pros cons of loans

Answer 8

\+instant money
\+no dilution
\+cheap if interest rates low
\+no shareholders to hold meetings
\+lender has no claim on future profits
-interest

Question 9

Pros cons of shares

Answer 9

+less repayment pressure than loans, only pay if able to
+shareholders can give advice
-dividends
-risk of loss of control dilution

Question 10

Use of financial ratios

Answer 10

Spot trends, strengths and weaknesses
Potential investors can use for analysis
Compare with competition

Question 11

What does low GPM suggest

Answer 11

Cost of goods is high. Either cut costs or increase price

Question 12

What does low OPM suggest and eval

Answer 12

Operating expenses high, so either cut costs in other areas, or lower fixed costs.

However, OP may be low due to big investments

Question 13

Liquidity ratios

Answer 13

Show how much money is available to pay debt

Question 14

What is considered a low current ratio, and what are the implications of a high one

Answer 14

Below 1.5=low suggests liquidity problems

High-too much working capital tied up in assets

Question 15

Evaluation of current ratio

Answer 15

Different firms have different requirements for holding assets
Consider competitions ratio

Question 16

Gearing-interest rates

Answer 16

High gearing-more affected by interest rates rise

Question 17

Gearing-risk

Answer 17

High gearing-greater risk as more interest paid, less profits and dividends

Question 18

Reason for low geared

Answer 18

Can cope with fall in profit, as can just reduce dividends, unlike loan repayments which have to be paid

Question 19

Reason for high gearing

Answer 19

Fund growth

Maintain ownership

Question 20

When is high gearing good (2)

Answer 20

In growth phase-profits high so can pay off loan (strong cash flow)
Low interest rates

Question 21

ROCE Importance

Answer 21

If higher than interest rate-better than putting in bank

Question 22

How to improve ROCE

Answer 22

Reduce NCL or increasing OP

Question 23

Benefit of low gearing

Answer 23

Less risk of interest defaulting debt

Question 24

Inventory turnover evaluation (4)

Answer 24

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

Question 25

Limitations of financial ratios (3)

Answer 25

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

Question 26

Pros of financial ratios (2)

Answer 26

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