Analysis of Published Accounts Flashcards
Define Liquidity
A measure of how easily a business could meet its short term debt or liabilities
What is the Current Ratio and how is it calculated?
It compares the current assets of a business with its current liabilities
Formula: Current Assets / Current Liabilities
What can the current ratio show us?
- The amount of cash tied up in unprofitable inventories
- The amount of current assets available to pay current liabilities
What is the Acid Test Ratio and how is it calculated?
Acid test ratio compares liquid assets to current liabilities
Formula : Current Assets - Inventory / Current Liabilities
What are some methods of improving Liquidity?
- Sell fixed assets for cash and leaseback
- Utilise JIT
- Increase loans to inject cash & increase working capital
What could be the limitations of these methods?
- Leasing charges can increase overheads
- Excellent supplier relationship is needed for JIT
- Gearing Ratio can increase
What is Profitability?
A relative measure if a businesses ability to make a profit from sales or capital investment
What is Gross Profit Margin and how is it calculated?
A ratio that compares gross profit with revenue
Formula : Gross Profit / Revenue * 100
What is Operating Profit Margin and how is it calculated?
A ratio that compares operating profit for a year with the revenue
Formula: Profit from Operations / Revenue * 100
What is Return on Capital Employed [ROCE] and how is it calculated?
A ratio that compares operating profit with capital employed in a business
Formula : Profit from operations / Capital Employed * 100
What are some methods that businesses can use to improve profitability?
- Reduce direct costs [i.e. raw materials, labour costs, automation]
- Increase prices
- Reduce overhead costs [i.e delayering, promotion costs, low cost sites]
Evaluate these methods.
- Quality and motivation can be affected or additional training costs could be required
- Customers could switch to competitors
- Delayering could reduce efficiency or create redundancy payments, promotion could reduce sales more than the fixed costs.
- Relocation to a lower cost site could damage image if it is not optimal
What are some methods to increase RoCE?
- Increase prices
- Reduce direct and indirect costs
- Reduce capital employed [i.e sell assets with less contribution]
What is the Rate of Inventory Turnover and how is it calculated?
The number of times in a year an inventory is bought and sold
Formula: COS / Avg Inventory
What is Trade Recieveables Turnover and how is it calculated?
The average time taken in days to recieve payment from credit customers
Formula : TR / Credit Sales * 365
What is Trade Payables Turnover and how is it calculated?
The average time taken in days to pay suppliers for materials bought on credit
Formula : TP / Credit Purchases * 365
What are some ways to improve Financial Efficiency of the business?
- Utilise JIT
- Reduce credit periods for customers
- Delay payments to suppliers
What are some problems that can arise with this?
- Customers may switch to those with longer credit offers
- Suppliers may remove discounts or refuse
- Risks of zero inventory
What is the Gearing Ratio and how is it calculated?
A ratio that measures the proportion of capital employed in the business that is financed by long term borrowing
Formula: NCL / Capital Employed * 100
What are the disadvantages of a high gearing ratio? [i.e, more than 50%]
- Higher fixed interest payments - lower retained earnings - lower dividends
- May discourage shareholder investment [risk]
- Banks can be reluctant to lend
What are some ways to improve the Gearing Ratio of a Business?
- Reduce dividends and increase retained profits to finance loans
- Reduce the amount of borrowing
- Issue more ordinary shares for increased capital
- Sell assets to raise finance
What are the problems with issuing additional shares?
- Exisiting shareholder ownership can be diluted
- Increased dividend payments are required
- Poor economic conditions could mean lower share prices
What are the problems with reducing dividends?
- Shareholders returns would be low
- The business may already be making lower profits
What are the problems with selling assets?
- It can reduce the value of the business and limits future expansion plans
- If assets are sold quickly, higher prices may not be achieved
