week 22 Flashcards
what are the measures of financial performance
gross profit margin
operating profit margin
net profit margin
why do we use ratios
financial statements provide information for users to evaluate financial performance and position of the company but are hard to compare
standardise information by accounting for size differences - allow comparability
what is cross-sectional analysis
compare different companies at the same time
what is time series analysis
same company over time
what are the four categories for ratios
measures of performance
measures of working capital
measures of solvency and liquidity
measures of return on investment and risk
what is measures of performance
measures of how the company is performing financially
what are measures of working capital
indicates the ability of the company to manage elements of working capital effectively
what are measures of liquidity and solvency
indicates the ability of the company to pay its liabilities as they fall due
what are measures of return on investment and risk
indicates the ability of the company to generate returns for its shareholders
what do performance ratio tell us
how efficiently a company is generating profit
contribution of income and expenses to financial profitability
performance of an entity regardless of how it is financed
give examples of performance ratios
gross profit margin
operating profit
net profit margin
return on capital employed
decomposition of ROCE
return on total assets
what do margins tell you
profit levels as a proportion of revenue
how do you calculate gross profit margin
(sales - cost of sales) / sales x 100
indicates a price premium a company commands for its products/services
how do you calculate operating profit margin
operating profit / sales x 100
indicates how efficiently a company can generate profit through its core operations
how do you calculate net profit margin
net profit / sales x 100
indicates how efficiently a company is able to generate profit, considering financing and tax expenses
how do you calculate return on capital employed
ROCE = operating profit / net capital employed x 100
or
operating profit margin x asset turnover ratio
indication of how effectively and efficiently a company has utilised its assets
how do you calculate net capital employed
equity capital + debt capital
or
total assets - current liabilities
how do you calculate asset turnover ratio
sales / (total assets - current liabilities)
measures a companies ability to generate sales from its assets
measures of level activity and productivity
different ratios in different industries due to different tech
how do you calculate return on total assets
operating profit / total assets x 100
does not take into account how assets are financed
how do you calculate average ROA over a year
average total assets = (total assets at year end + total assets at previous year end) / 2
ROA = operating profit / average total assets x 100
what is working capital
amount of capital required for daily operations
why should you manage working capital
reduces need for short term financing
reduces pressure on cash
how do you calculate net current assets
net current assets = current assets - current liabilities
what are the three components of working capital
trade recievables
inventories
trade payables
what are the two forms of working capital ratios
periods (number of days)
settlement period for trade receivables
payment holding for trade payables
inventory holding period
operating cash cycle
times
trade receivable turnover
trade payable turnover
inventory turnover
how do you calculate settlement period for trade receivables
trade receivables / credit sales x 365 days
if you don’t know credit sales, use revenue
what does settlement period show
time it takes for a company to receive cash from customers, longer settlement period means cash is occupied for longer
how do you calculate average trade receivables over the year
(average trade receivables / credit sales) x 365 days
what does the settlement period for trade receivables show
abnormally high period of credit may indicate poor credit control procedures
collection periods may be influenced by seasonal business
average period varies between industries
how do you calculate payment period for trade payables
trade payables / credit purchases x 365 days
indicates average length the company pays trade payables
the longer the payment period, the shorter time the cash is occupied
how do you calculate average period for trade payables
average trade payables / credit purchases x 365 days
what does the payment period for trade payables show
if payment period is high relative to other firms, may indicate financial distress
beneficial to delay paying suppliers but may affect credit rating
how do you calculate the inventory holding period
inventory / cost of good sold x 365
longer inventory hold, longer cash is occupied
how do you calculate average inventory holding period
average inventory / cost of goods sold x 365 days
how do you manage working capital
minimise the length of the operating cash cycle
shorter time between paying suppliers and receiving payments from customers
what is the entire operating cycle
the period from buying goods to collecting sales generated cash
what is the operating cash cycle
the period from paying for goods to collecting sales generated cash
how do you calculate operating cash cycle
inventory holding period + settlement period for receivables - payment period for payables
how do you calculate trade receivables turnover
credit sales / trade receivables
how many times a company collects its trade receivables during a year
the higher the turnover the shorter the time between sales and cash collection
how do you calculate settlement period for trade receivables
365 days / trade receivables turnover
what does high trade receivables turnover show
efficient collection of receivables
customers have low bargaining power
sales are mostly in cash rather than credit
what does low trade receivables turnover show
inefficient collection of receivables
customers have high bargaining power
company is extending favourable credit terms to attract more customers
how do you calculate trade payables turnover
credit purchase / trade payables
measures how many times a company pays off its trade payables over a year
how do you calculate trade payables payment period
365 days / trade payables turnover
what does high trade payables turnover show
suppliers have more bargaining power and demand for fast payment terms
the company may want to take advantage of early payment discount
what does low trade payables turnover show
the company has more bargaining power than its suppliers so it can pay off the trade payables late
the company is in bad financial condition as it is unable to pay off the payables quickly
how do you calculate inventory turnover
cost of goods sold / inventory
measures how many times a company can sell and replace inventory in a year
what does low inventory turnover show
weak sales or excess inventory
what does high inventory turnover show
strong sales or insufficient inventory
how do you calculate inventory holding period
365 days / inventory turnover
