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AC102 > Week 8 Ratios > Flashcards

Week 8 Ratios Flashcards

1
Q

What are lenders interested in

A

liquidity and solvency ratios

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2
Q

what are shareholders interested in

A

profitability ratios and future share prices

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3
Q

What are the types of profitability ratios

A

ROCE
ROE
Operating profit margin, net profit margin
Gross profit margin

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4
Q

ROCE Formula and what is assesses

A

ROCE = operating profit (profit before interest) / share capital+ non current liabilities + reserves

assesses effectiveness of the total capital employed

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5
Q

ROE formula and what it assesses

A

ROE = profit for year less dividends / share capital + reserves

assesses return to shareholders

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6
Q

Operating profit margin formula and what it assesses

A

OPM = operating profit / sales revenue

measures operational performance

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7
Q

Gross profit margin formula and what measures

A

GPM = gross profit/sales revenue

measures directly trading performance

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8
Q

mark up formula and what it shows

A

mark up = gross profit / cost of sales

shows how much more a company’s selling price is than the amount the item costs the company

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9
Q

how to interpret profitability ratios

A

how do company’s returns compare to industry benchmarks?

Are margins consistent with the stated strategy?

Are the margins changing? Why?

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10
Q

What do efficiency ratios show

A

How long is inventory held
how long does it take customers to pay
how long does it take for the company to pay
how effectively does the company use its assets

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11
Q

Inventory days formula and measures what

A

inventory days = average inventories held/cost of sales x365 days

measures how long it takes on average for inventory to be sold (you want it to be as low as possible)

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12
Q

reasons as to why inventory days could be decreasing

A

sudden increase in demand

stocking up on inventory for holiday selling season or take advantage of trade discounts

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13
Q

receivables days formula and meaning

A

receivables days = average trade receivables/credit sales x365 days

shows how long on average credit customers take to pay the amount they owe to the business

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14
Q

payables days formula and meaning

A

payables days = average trade payables/creditpurchases x 365 days

shows how long the company takes to pay creditora

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15
Q

net asset turnover formula and meaning

A

NAT = sales revenue / share capital + reserves + concurrent liabilities

shows how effectively the entity uses its resources to generate sales

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16
Q

why does a business need working capital

A

retail - needs to buy and hold inventories

manufacturing - holds inventories of raw materials and part finished goods

17
Q

what should be the aim of a company in terms of working capital

A

avoid excessive working capital which creates unnecessary cost

avoid having insufficient amounts of working capital as it can lead to difficulties with cash flow and liquidity

18
Q

how to calculate operating cash cycle

A

average inventories holding period
+ average settlement period for receivables
- average payment period for payables
= operating cash cycle

19
Q

problems with low receivables days

A

customers could go elsewhere to buy on credit since they don’t have a very long period of credit

20
Q

what are liquidity and solvency ratios used for

A

credit risk analysis

21
Q

what does liquidity show

A

short term ability to generate cash for working capital needs and immediate debt repayments

22
Q

what do solvency ratios show

A

long term ability to generate cash internally or externally to satisfy capacity needs, fuel growth and repay debts

23
Q

current ratio formula and measures

A

current ratio = current assets/current liabilities

you want this to be high

compares liquid assets of the company with its current liabilities

24
Q

what is the acid test ratio formula and measures

A

acid test ratio = current assets - inventory / current liabilities

want this to be high

more rigorous measure of liquidity that excludes inventory

25
Q

what is cash ratio formula and what does it show

A

cash ratio = operating cash flows / current liabilities

want this to be high

most rigorous measure of liquidity

26
Q

what is financial gearing

A

occurs when a business is financed partly by debt to finance growth and exploit tax advantages

27
Q

dangers of high financial gearing

A

less control over financing decisions
risk of bankruptcy
high volatility profits available to shareholders
limited flexibility due to restrictions imposed on loan agreements

28
Q

gearing ratio formula and measure

A

gearing ratio = concurrent liabilities / share capital+reserves+noncurrent liabilities

measures contribution of long term debt to capital structure of the company

29
Q

interest coverage ratio formula and meaning

A

interest cover = operating profit / interest payable

shows the amount of profit available to cover interest

want to be high

30
Q

how to interpret liquidity and gearing ratios

A

does company have enough liquid funds
does company have enough debt ie is it exploiting the potential benefits of debt interest tax shields
does company have too much debt
what is the company doing with borrowed funds

31
Q

what are the four investment ratios

A

dividend payout ratio
dividend yield ratio
earnings per share
price/earnings ratio

32
Q

dividend payout ratio formula and meaning

A

dividend payout ratio = dividends announced for year / profit after tax less preference dividend

want it to be high

shows what proportion of profits is paid out as dividends to shareholders

33
Q

dividend yield formula and measure

A

dividend yield = dividend per share / share price

want to be high

shows cash return to a share relative to its current market value

34
Q

EPS formula and meaning

A

EPS = profit after tax less preference dividend / number of ordinary shares in issue

want to be high

represents the earnings available to shareholders per share issued

35
Q

P/E ratio formulaa and meaning

A

P/E ratio = market cap/net income ie market value per share / earnings per share

want to be high

measures market confidence in future earnings power of a business

AC102 (10 decks)

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