Financial health ratios

Question 1

What are financial health ratios

Answer 1

ratios that investigate the short-term and long-term financial stability of a firm by examining the relationships between the assets and liabilities

Question 2

current ratio definition

Answer 2

ratio that measures the firm’s ability to cover its short-term debts (current liabilities) with its current assets

Question 3

current ratio equation

Answer 3

current assets / current
liabilities

= a:b

Question 4

what is the average broad current ratio recommendation

Answer 4

1.5:1

Question 5

what is a problem with too high of a current ratio

Answer 5

too much cash sitting around idle doing nothing

Question 6

What is a problem with a business that has a current ratio too low

Answer 6

too much lower and the business risks not being able to cover its short-term debts

Question 7

gearing ratio definition

Answer 7

thus ratio focuses on the long-term financial health of the business

• it measures the extent to which the company is financed by borrowed money
  (I.E the proportion of capital employed made up of non current liabilities, or long term loans)

Question 8

gearing ratio calculation

Answer 8

non current liabilities
/
capital employed
x 100

Question 9

capital employed calculation

Answer 9

non current liabilities + total equity

Question 10

when is a business considered highly geared

Answer 10

if gearing is more than 50% of capital employed, this business has to pay interest on their loans
- the higher the gearing the higher the risk

Question 11

what is a benefit of being a low geared company

Answer 11

they provide lower risk investment, therefore they can negotiate loans more easily and at a lower cost than a highly geared company

Question 12

when are banks especially reluctant to lend to a firm

Answer 12

when the firm has poor liquidity and high gearing.

• why it is always worth calculating the current ratio too