Week 4 & 5 - Analysis of Financial Statements 2 Flashcards by Klaus Juul

Q

What is a ratio and what is it important to compare it to?

A

1) Two numbers, with one expressed as a ratio (or percentage) to the other,
• from Income Statement, and/or Statement of Financial Position

2)
- Trend over time
- Benchmarking to industry, competitors etc.
- Comparison to target or expectation

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Q

What are the five areas for ratio analysis?

A

Profitability
Liquidity, i.e. cash flow
Gearing, i.e. the proportion of borrowings to shareholders investment
Efficiency of use of assets
Shareholder returns

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Q

What is the following ratio analysis about:

Profitability

A

increasing rates of profit on shareholders’ funds, capital and sales

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Q

What is the following ratio analysis about:

Liquidity, i.e. cash flow

A

adequate liquidity to ensure debts can be paid, but not such that funds are inefficiently used

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Q

What is the following ratio analysis about:

Gearing

A

debt commensurate with the business risk taken

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Q

What is the following ratio analysis about:

Efficiency of use of assets

A

efficiency through using investments to maximise sales

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Q

What is the following ratio analysis about:

Shareholder returns

A

a satisfactory return on the investment made by shareholders

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Q

What are the profitability ratios?

A

Return on (shareholders’) investment (ROI)
Return on capital employed (ROCE)
Operating margin (Operating profit/sales)
Gross margin (Gross profit/sales)
Overhead/sales

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Q

What are the liquidity ratios?

A

Working capital
Acid test (or quick ratio)

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Q

What are the gearing ratios?

A

Gearing
Interest cover

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Q

What are the Activity/efficiency ratios?

A

Asset turnover

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Q

Formulae for ROI:

A

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Q

Formulae for ROI

and what does it stand for

A

Return on investment

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Q

Formulae for ROCE

And what does it stand for?

A

Return on capital employed

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Q

Formulae for Operating profit/sales

A

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Q

Formulae for Gross profit/sales

A

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Q

Formulae for Overhead/sales

A

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Q

Formulae for Working capital

What is the level of the ratio that most companies seek?

A

150% (/1.5) - balancing efficiency and risk of not paying debt

Q

Formulae for Acid test (quick):

And what is the level that companies seek?

A

100% (/1)

Q

Formulae for Gearing

What level do companies seek?

A

Many seek 40%-60%

Q

Formulae for Interest cover

A

Q

Formulae for Asset turnover

A

Q

Which to areas are (according to professor) key areas of analysis?

A

Gearing
Working Capital

Q

Why are Gearing and Working Capital key areas of analysis?

A

Why?

Risk
Return

• Cash

Explain consequences of different debt/equity mix

Explain the working capital cycle

How can you manage working capital?

1. Managing receivables through effective credit approval, invoicing and collection activity; 2. Managing inventory through effective ordering, storage and identification of stock; 3. Managing payables by negotiation of trade terms and through taking advantage of settlement discounts; and 4. Managing cash by effective forecasting, short-term borrowing and/or investment of surplus cash where possible.

What are the two formulaes to evaluate the managing of receivables and inventory?

DSO (Days Sales outstanding) Stock turn

What is the formulae for DSO (Days sales outstanding)?

=number of days of sales that have still not been paid to us

What is the formulae for Stock turn?' Do you want it to be high or low?

= renew stock every XXth day low

What is the name of the ratio to evaluate the managing of payables? Do you want it to be high or low?

Days' purchases outstanding high

What is the formulae to calculate Days’ purchases outstanding (DPO)? Do you want it to be high or low?

high

What are the shareholder return ratios?

1. Dividend per Share 2. Dividend Payout Ratio 3. Dividend Yield 4. Earnings per share 5. Price/Earnings (P/E)

What's the formulae for ## Footnote Dividend Payout Ratio

What's the formulae for ## Footnote Dividend per Share

What's the formulae for ## Footnote Dividend Yield

What's the formulae for ## Footnote Earnings per share

What's the formulae for ## Footnote Price/Earnings (P/E)

What is important to remember when interpreting profitability ratios?

* Increased profits (more sales, higher margins, lower costs) or lower capital * Higher profit (in £s) is not the same as a higher rate of profit (the % to sales) * Improved rate of gross profit may be the result of higher selling prices, lower cost of sales or changes in product mix (or any combination of these)

When interpreting liquidity, what is important to remember?

• Improvements are the result of changing the balance between current assets and current liabilities * May be improved by long-term borrowing * Repaying long-term debt will reduce liquidity

What is important to remember when interpreting gearing ratios?

1) Gearing • Affected by more shares being issued, new borrowings or repayment of debt 2) Higher profits will improve interest cover

What is important to remember when interpreting activity/efficiency ratios?

• Improved due to increase in sales or reduction in assets. Efficient collection of debtors and management of inventory.

When interpreting shareholder return ratios, what is important to remember?

* Paying higher dividends may lead to borrowings for capital investment, but lower dividends are not favoured by investors * Share price is a result of market expectations about the company’s future * An increase in the number of shares will also affect these ratios