Ratios

Question 1

Gross profit margin

Answer 1

(Gross profit/
Sales revenue) ×100%

Question 2

operating profit margin

Answer 2

(Profit from operations /
Sales revenue) ×100%

Question 3

Return on capital employed (ROCE)

Answer 3

ROCE =
(Profit/
Capital employed) × 100%

Question 4

ROCE shows the ability of the entity to

Answer 4

turn its long-term financing into profit.
Profit is measured as:
 operating (trading) profit, or
 the profit before interest and taxation (PBIT), i.e. the profit before taking
account of any returns paid to the providers of long-term finance.

Question 5

Similar to ROCE is return on equity (ROE):

Answer 5

ROE =
(Profit after tax/
Equity)
× 100%

Question 6

ROE can be used to show

Answer 6

the return made for the year on the total equity in the
business. Pre-tax ROE can also be calculated using profit before tax rather than
profit after tax.

Question 7

net asset turnover

Answer 7

(Sales revenue/
Capital employed) = times pa

the higher the asset turnover, the greater the efficiency.

Question 8

Note that asset turnover can be subdivided into:

Answer 8

 non-current asset turnover (by making non-current assets the
denominator) and
 working capital turnover (by making net current assets the denominator)

Question 9

ROCE can be subdivided into profit margin and asset turnover.

Answer 9

Profit margin × Asset turnover = ROCE

PBIT/
Sales revenue
×
Sales revenue/
Capital employed
=
PBIT/
Capital employed

Question 10

Low-margin businesses (e.g. food retailers) usually have a high

Answer 10

Asset turnover

Question 11

Capital-intensive manufacturing industries (e.g. electrical equipment
manufacturers) usually have relatively

Answer 11

low asset turnover but higher margins

Question 12

Two completely different strategies can achieve the same ROCE.

Answer 12

 Sell goods at a high profit margin with sales volume remaining low (e.g.
designer dress shop).
 Sell goods at a low profit margin with very high sales volume (e.g. discount
clothes store).

Question 13

There are two ratios used to measure overall working capital:

Answer 13

 the current ratio
 the quick or acid test ratio.

Question 14

Current or working capital ratio:

Answer 14

Current assets/
Current liabilities : 1

Question 15

The current ratio measures

Answer 15

the adequacy of current assets to meet the liabilities as they fall due

Question 16

A high or increasing figure may appear safe but should be regarded with
suspicion as it may be due to:

Answer 16

 high levels of inventory and receivables (check working capital
management ratios)
 high cash levels which could be put to better use (e.g. by investing in noncurrent
assets).

Question 17

Traditionally, a current ratio of 2:1 or higher was regarded as
appropriate for most businesses to maintain creditworthiness. However,
more recently a figure of

Answer 17

1.5:1 is regarded as the norm.

Question 18

Quick ratio (also known as the liquidity or acid test) ratio:

Answer 18

Quick ratio =
Current assets – inventory /
Current liabilities :1

Question 19

The quick ratio is also known as the acid test ratio because by eliminating
inventory from current assets it provides the acid test of whether the company

Answer 19

has sufficient liquid resources (receivables and cash) to settle its liabilities.

Question 20

Inventory holding period

Answer 20

Inventory/
COS × 365 days

Question 21

Receivables collection period is normally expressed as a number of days:

Answer 21

Trade receivables/
Credit sales × 365 days

Question 22

Payables payment period is usually expressed as:

Answer 22

Trade payables/
Credit purchases × 365 days

Question 23

Working capital cycle (cash cycle)

Answer 23

Inventory turnover period (days)
+ receivables collection period – payables payment period

Question 24

In highly geared businesses:

Answer 24

 a large proportion of fixed-return capital is used
 there is a greater risk of insolvency
 returns to shareholders will grow proportionately more if profits are
growing.

Question 25

Low-geared businesses:

Answer 25

 provide scope to increase borrowings when potentially profitable projects
are available
 can usually borrow more easily.

Question 26

There are two methods commonly used to express gearing.

Answer 26

Debt/equity ratio:

Percentage of capital employed represented by borrowings:

Question 27

Debt/equity ratio:

Answer 27

Loans + Preference share capital/

Ordinary share capital + Reserves + Non-controlling interest

Question 28

Percentage of capital employed represented by borrowings:

Answer 28

Loans + Preference share capital/

Ordinary share capital + Reserves + Non-controlling interest
+ Loans + Preference share capital

Question 29

Interest cover

Answer 29

Profit before interest and tax/
Finance costs

Question 30

interest cover of less than

Answer 30

two is usually considered unsatisfactory

Question 31

low interest cover indicates to shareholders that their

Answer 31

dividends are at risk

Question 32

Price / Earnings (P/E) ratio

Answer 32

P/E ratio =
Current share price/
Latest EPS

Question 33

Dividend yield

Answer 33

Dividend per share/
Current share price