7.2d - Ratios (ROCE) Flashcards
Ratio analysis definition
The interpretation of financial performance indicators to provide useful insights
Return on capital employed definition
How well a business has performed against the money invested into it
Why is important to compare ROCE with the interest rate?
It tells investors whether they would be better off putting money in the bank
ROCE formula
(Operating profit / capital employed) X 100
Why can it be bad for a business to have too high a profit margin?
- Too high prices so lose customers
- Attracts competition
What does it mean if profit is of high quality?
It is from a recurring activity
What do you need to watch out for in ROCE?
Low quality profit boosting ROCE
How can a business improve ROCE?
- Pay off debt to reduce non-current liabilities
- Making the business more efficient to increase operating profit
Disadvantages of ratios:
- Figures are historic
- Says what but not why
- Non-financial assets not included
- Can only compare similar businesses
How can ratios be used?
- Spot trends
- Compare against competitors
- Potential investors can decide whether to invest
- Help with decision making
