Interpretation of final accounts - 5a

Question 1

What is profitability?

Answer 1

The ability of a firm to use its asset base in order to increase the total assets

Question 2

What is solvency?

Answer 2

This refers to the ability of a firm to pay off its short term debt

Question 3

What is efficiency?

Answer 3

This refers to the efficiency with which the firm manages its current assets and current liabilities.

Question 4

What is investor suitability?

Answer 4

This refers to the attractiveness of the firms shares as an investment.

Question 5

Return on capital employed formula

Answer 5

Net profit before tax and interest x100
/
All shareholders funds plus loans

Question 6

Net profit margin formula

Answer 6

Net profit before tax x 100
/
Turnover

Question 7

Gross profit margin formula

Answer 7

Gross profit before tax x 100
/
Turnover

Question 8

The current ratio formula

Answer 8

Total Current Assets: Total Current Liabilities

Question 9

Acid Test Ratio

Answer 9

Total Current Assets - inventory : Total Current Liabilities

Question 10

What should the current ratio typically be?

Answer 10

at least 1.5 : 1

Question 11

What should the acid test ratio typically be?

Answer 11

at least 1 : 1

Question 12

Debt collection period formula

Answer 12

(receivables x 365)
/
annual credit sales

Question 13

Creditor payment period formula

Answer 13

(trade payables x 365)
/
annual credit purchases

Question 14

Rate of inventory turnover (stock turn) formula

Answer 14

Cost of sales
/
Average inventory holding during year

Question 15

What other measures are increasingly being used in order to evaluate the performance of particular retail units?

Answer 15

• sales revenue per employee
• sales per footfall
• sales per meter of floor area

Question 16

Capital gearing formula:

Answer 16

(Long-term debt x 100)
/
All finance

Question 17

Earnings per share

Answer 17

Annual earnings (usually measured as profit after tax)
/
number of ordinary shares in issue.

Question 18

Dividend per share formula

Answer 18

Ordinary Dividends (interim plus final)
/
Number of issued ordinary shares

Question 19

Yield formula

Answer 19

Latest Ordinary dividend (interim plus final)
/
Current market price of share

Question 20

Price/ Earnings ratio:

Answer 20

Latest market price of share
/
Latest Earnings per share

Question 21

Why is ratio analysis undertaken?

Answer 21

• Simplify the information in the accounts
• Allow comparison of different sized firms

Question 22

Limitations of ratio analysis:

Answer 22

• Ratios are only as reliable as the data from which they are drawn i.e: if the accounts are not true and fair, then neither are the ratios.
• Many factors cannot be measured by statistics e.g strategic vision, staff morale, ethical/environmental stance.
• The figures have limited meaning without “comparatives” e.g: industry average ratios, ratios of previous years.
• Ratios are only the tip-of-the-iceberg: need to refer to the accounts (and notes) for underlying reasons.