Wk 6 Financial Statement Analysis

Question 1

What is ratio analysis?

Answer 1

Uses financial and non-financial data to make comparisons to help remove the impact of scale and inflation - helps the users of financial decisions to make informed decisions

Question 2

What are comparisons made with?

Answer 2

• earlier years
• the company’s plan
• other companies in the same industry
• the industrial average

Question 3

What are the 4 different types of ratio analysis?

Answer 3

• profitability ratios (aid in judging how well the company is being run by management)
• liquidity ratios (aid judgement of the adequacy of company’s cash and near cash resources)
• efficiency ratios (provides information about the speed with which a company transforms purchases into sales and then into cash)
• gearing ratios (measurement of the company’s financial risk)

Question 4

What’s is the profitability ratio analysis?

Answer 4

Gross profit margin: gross profit/sales revenue * 100%
higher the better
Operating profit margin: operating profit/sales revenue *100 %
degree of competitiveness in the market

Question 5

What is the liquidity ratio analysis?

Answer 5

Current ratio: current assets/current liabilities (x:1)
Higher the better, helps decision makers to understand whether there are sufficient short-term assets present to settle short-term liabilities
Acid test (quick) ratio: (current assets - inventory) / current liabilities (x:1)
Helps decision makers to understand whether there are sufficient short-term (highly liquid assets) present to settle short-term liabilities, inventory excluded from calculation

Question 6

What is the efficiency ratio analysis?

Answer 6

Trade receivable settlement period: trade receivable/sales revenue * 365
Number of days, lower the better (within reason), measures the speed with which a company collects cash from their credit customers
Inventory holding period: inventory/cost of sales * 365
Measure of how quickly goods move through the business, lower the better (within reason)
Trade payable settlement period: trade payables/cost of sales * 365, measures the speed with which a company pays its supplier, higher the better (within reason)

Question 7

What is the gearing ratio analysis?

Answer 7

Gearing: non-current liabilities/(equity + non-current liabilities) * 100
Higher figure indicates reliance on sources of long-term loan finance, shows how much of a company’s operations are funded by equity or debt
Interest cover: operating profit/interest expense
Higher the better, indicates how ‘safe’ the annual interest payments are in relation to profit - how many times profits can fall before the company is unable to cover payments out of current profits

Question 8

What are non-current liabilities?

Answer 8

Debt that a business owes but isn’t due to pay for > 12 months

Question 9

What are the limitations of ratio analysis?

Answer 9

• lack of standard ratio definition
• closing balances in statement of financial position may not represent the average position of the company over the financial year
• accounting policies could differ, possible misinterpretation
• more information needed to make well informed decisions

Question 10

What is the working capital cycle?

Answer 10

Receivable days + inventory days - payables days