3.6 Flashcards
(38 cards)
What do efficiency ratios measure?
How a firm uses assets and liabilities to generate sales and maximize profits
Efficiency ratios provide insights into operational efficiency.
What does stock turnover measure?
How well a firm converts its stocks into sales
Stock turnover is calculated as Cost of Goods Sold divided by Average Stock.
What is the ideal trend for stock turnover ratios?
Higher is better; firms aim for high/increasing ratios
More stock sold leads to more profit generated.
What does a lower stock turnover ratio indicate?
Selling stock quickly and less likelihood of holding obsolete stock
Low stock turnover might be good for some businesses and bad for others.
What are some methods to improve stock turnover?
- Hold less stock
- Reduce cost of sales
- Reorder from suppliers more regularly
- Implement just-in-time stock management
- Dispose of obsolete stock
- Reduce product range
- Seek lower-cost suppliers
- Purchase in bulk
- Reduce storage costs
What does gearing illustrate?
The long-term financial structure of a business
It shows the balance of non-current liabilities to shareholder capital used to fund the firm.
What is considered a good gearing ratio?
25% - 50% is good
What does a gearing ratio of less than 50% indicate?
The business is low-geared, largely funded by shareholder capital
What does a gearing ratio greater than 50% indicate?
The firm is high-geared, largely funded by loan capital
Fill in the blank: Stock turnover is an indicator of how efficiently a business converts _______ to sales.
stock
How many days does creditor days measure?
How many days it takes to pay debts
What is the significance of debtor days?
It indicates how many days it takes to collect money owed
What does a higher gearing ratio indicate?
More dependent on long-term borrowings
A higher gearing ratio implies increased financial risk due to reliance on debt.
What financial risk is associated with high gearing?
Cash flow & investment constraints
High gearing can limit a firm’s ability to invest in new projects or growth opportunities.
When is high gearing less problematic?
When interest rates are low and large, profitable businesses can meet debt obligations
Low interest rates reduce the burden of debt repayments.
What happens to businesses when interest rates rise?
Cost of repaying loans rises, putting strain on finances
Rising interest rates can reduce profitability as more revenue is allocated to debt repayments.
What are the options for improving gearing ratio?
- Reduce long-term borrowing
- Raise equity capital
- Retain profits instead of distributing as dividends
Improving the gearing ratio can enhance financial stability.
What investor perception is associated with high gearing?
It is associated with financial risk, potentially leading to lower share prices
High gearing can make it difficult to attract new investors.
What should firms aim for regarding Debtor Days?
Aim for low or reducing ratio (30-60 days)
Prompt collection of debts improves cash flow.
What can be a consequence of not collecting debts on time?
Lack of working capital
If debts are unpaid, a firm may face cash flow issues affecting operations.
What methods can be used to reduce Debtor Days?
- Refuse to provide further goods unless debts are paid
- Threaten legal action
- Suspend orders until payments are received
These methods should be used cautiously to maintain customer relationships.
True or False: High gearing can lead to attractive returns if profitability is high.
True
High profitability can offset the risks associated with high gearing.
What does a high credit period indicate for a business?
It suggests liquidity problems and that customers are seeking better credit terms
A high credit period may signal that the business is not competitive and customers are looking for alternative suppliers.
What are creditor days?
Average number of days it takes a firm to pay its creditors
Creditor Days = (365 / Cost of Goods Sold)
