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Week 5 - Interpretation of Accounts Flashcards

1
Q

Interpretation of accounts is

A

a detailed explanation of the financial performance of an entity incorporating data and other quantitative and qualitative information extracted from both internal and external sources

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2
Q

Main techniques for interpretation of accounts are

A
  1. horizontal/trend analysis
  2. vertical analysis
  3. ratio analysis
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3
Q

Horizontal/Trend Analysis involves

A

making line-by-line comparison of the company’s accounts for each accounting period

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4
Q

Vertical Analysis requires

A

the figures in each financial statement to be expressed as a percentage of the total amount

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5
Q

Ratio Analysis expresses

A

the relationship between two numbers expressed as percentage or other factor

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6
Q

5 main areas of Ratio Analysis

A
  1. Liquidity
  2. Gearing/Solvency
  3. Profitability
  4. Operational/Activity
  5. Investor
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7
Q

Liquidity is

A

a company’s ability to meet its current obligation

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8
Q

2 liquidity ratios

A

Current
Acid-test
(expressed as a factor = 3:1)

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9
Q

Current Ratio =

A

Current Assets / Current Liabilities

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10
Q

Acid-test Ratio =

A

(Current Assets - Inventory) / Current Liabilities

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11
Q

Gearing/Leverage is

A

the amount the business has borrowed (debt) relative to the amount of finance provided by the owners of the business (equity). High percentage = highly geared

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12
Q

Gearing =

A

Long Term Loans / Total Equity
(expressed as a percentage)

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13
Q

Profitability is

A

the amount of profit that a business generates from its operations

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14
Q

4 profitability ratios are

A
  1. Gross Profit/margin
  2. Net proft
  3. Return on Capital employed
  4. Return on Equity
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15
Q

Gross Profit/margin Percentage =

A

Gross Profit / Sales

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16
Q

Net Profit Percentage =

A

Profit Before Interest and Tax (PBIT) / Sales

17
Q

Return on Capital Employed (ROCE) =

A

Profit Before Interest and Tax (PBIT) / Capital Employed

18
Q

Return on Equity (ROE) =

A

Profit Before Tax / Equity

19
Q

Operational/Efficiency Ratios measure

A

how efficiently the firm manages its resources (fixed assets, inventory, debtors and creditors)

20
Q

4 efficiency ratios

A
  1. stock turnover
  2. asset turnover
  3. debtors days
  4. creditors days
21
Q

Stock Turnover =

A

Avg. inventory x 365 days / cost of goods sold

22
Q

Asset Turnover =

A

Sales / Fixed Assets

23
Q

Debtors Days =

A

Avg Debtors x 365 days / Credit Sales

24
Q

Creditors Days =

A

Avg. Creditors x 365 days / Credit purchases*

*or Cost of sales if credit purchases not available

25
Q

Inventory turnover is a

A

measure of how many times the average inventory level is sold each year

26
Q

Asset turnover is

A

a measure of how efficiently the Fixed Assets of the business are generating sales

27
Q

Debtors days measures

A

the average number of days it takes customers to pay the business

28
Q

Creditors days measures

A

the average number of days the business takes to pay suppliers

29
Q

Investor ratios measure

A

the profits of the business and the returns that are generated to investors in the form of dividends

30
Q

2 main investor ratios (covered on this course)

A
  1. Earnings per Share (EPS)
  2. Price Earning Ratio (P/E)
31
Q

Earnings per Share (EPS) =

A

Profit After Tax and Preference Dividend / Number of Ordinary Shares Issued

32
Q

Price Earning Ratio (P/E) =

A

Market Price Per Share / EPS

33
Q

Earnings per Share (EPS) measures

A

how much each share issued by the firm generated for the investor in terms of profit earned. Not all profit is returned directly to the shareholders in the form of dividends, the profit which is not distributed will be retained and will grow the business. Comparing EPS over a number of years will allow an investor to see if the company is growing

34
Q

Price Earning ratio (P/E) relates

A

the current earnings of the business to the current share price of the business. Provides a crude payback period for the time taken to repay the investment in terms of the current share price with the number of years of earnings. The higher the P/E ratio, the greater the confidence in the firm’s future prospects.

35
Q

Limitations of ratios

A
  • Deal with figures only, non-financial qualities of the business are often not apparent (skills and general morale of the workforce will not show up in data)
  • Is financial data consistent over time?
  • If comparison is made with other organizations, is there consistency of accounting policies? (ex. depreciation)
  • The reasons for changes in ratios perhaps not immediately apparent
  • Ratios generally use historical data and provide no real basis for future predicitions
  • Ideal ratios are guidelines only and vary from business to business

Accounting (9 decks)

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