7. Liquidity ratios. Financial Gearing, Investment ratios Flashcards
(14 cards)
What is Liquidity ratio?
Liquidity ratios are concerned with the ability of the business to meet its short-term obligations
.
The types of liquidity ratios are:
* Current ratio -
* Acid test ratio
* Operating cash flow to maturing obligations
Current ratio
The current ratio compares the ‘liquid’ assets (that is, cash and those assets held that will soon be turned into cash) of the business with the current liabilities.
Current assets/current liabilities
The lower the ratio the worse and vice versa - look at formel.
Ideal current ratio is 2:1 where there are more assets than liabilities.
But the 2:1 ratio does not work for all businesses.
One business entity may not own much asset and are more liquid than those that own more assets but are not liquid
Asset Test Ratio
Not different from current ratio.
BUT it does not take inventory into considerations = Inventory is excluded because inventories cannot be converted to cash quickly. In part due to trades receivables.
Current assets (excl. inventory)/current liabilities
A ratio of 1 (or 1:1) or higher is generally considered acceptable.
1 indicates that the company’s quick assets are sufficient to cover its immediate liabilities.
Cash generated from operations to maturing obligation
Another financial metrics that assess a company’s ability to meet short-term liabilities is the cash generated from operations to maturing obligations = How much money came in and how much of it can cover the liabilities / meet the shortages?
Different from the others = other liquidity ratios measures a company’s ability to meet its short-term obligations using its current assets. THIS evaluates a company’s ability to generate sufficient cash from its core operations to meet upcoming short-term liabilities
The higher this ratio is, the better the liquidity of the business.
Operating cash cycle
After you have made the different ratios, you look at how quickly can inventory and trade receivable be traded into cash = cash operating cycle.
OBS:
If a company take too long to sell inventory or collect reciveables = cash tied up in operation = lead to lower ower liquidity ratios, even if the company has strong sales.
A long OCC means the company may struggle to pay suppliers and short-term debts on time, leading to liquidity risks.
=
Shorter OCC will result in Higher Liquidity AND Longer OCC will result in Lower Liquidity. (payback late)
Operating cash cycle
=Average inventory holding period + Average settlement period for trade receivables - Average settlement period for trade payables
SEE PICTURE
The gearing ratio
Long term capital vs long term liabilities
Gearing ratio viser, hvor stor en andel af virksomhedens langsigtede kapital der kommer fra gæld (fremmedfinansiering) i forhold til egenkapital.
Det er et vigtigt nøgletal for finansiel risiko – altså hvor afhængig virksomheden er af lån til at finansiere sine aktiviteter
Gearingratio=Long-term(non-current)liabilities /
Sharecapital+Reserves + Long-term(non-current)liabilities
Types of Financial gearing
- The gearing ratio
- The interest cover ratio.
The interest cover ratio.
The interest cover ratio measures the amount of operating profit available to cover interest payable (interest paid).
Operating profit / interst payable
An interest cover ratio of 1.5 times indicates that the company’s operating income is 1.5 times greater than its interest expenses, suggesting a moderate level of coverage and financial stability
In the EXSAMPLE it is calculated to 1,5.
So, there is a moderate risk level here
What is investment ratios?
Do we want to be a part of an investment? helps assess their investments or future investments.
- dividend payout ratio
- dividend yield ratio
- earnings per share
- cash generated from operations per share
- price/earnings ratio.
Dividend payout ratio
The dividend payout ratio measures the proportion of earnings that a business pays out to shareholders in the form of dividends
- Ratioen viser, hvor generøs eller tilbageholdende virksomheden er med at udbetale overskud.
- Et højt tal (fx 80 %) betyder, at størstedelen af overskuddet udbetales.
- Et lavt tal (fx 20 %) betyder, at det meste tilbageholdes i virksomheden (fx til investeringer eller opsparing).
Dividend yield ratio
The dividend yield ratio relates the cash return from a share to its current market value.
This can help investors to assess the cash return on their investment in the business.
Dividend Yield Ratio viser, hvor stort et kontantafkast en investor får pr. aktie i forhold til aktiens nuværende markedspris
Earning per share
What earnings are available to ordinary shareholders.
Cash generated from operations per share
Dette nøgletal viser, hvor meget kontantstrøm fra den daglige drift der er genereret pr. ordinær aktie, efter der evt. er fratrukket præferenceudbytte.
Price/earnings ratio.
The price/earnings ratio relates the market value of a share to the earnings per share.
P/E-ratioen (Price/Earnings ratio) viser forholdet mellem en akties markedskurs og dens indtjening pr. aktie (EPS)
His share cost this amount - this provide the information
