Financial ratios

Question 1

Current ratio

Answer 1

Current assets / Current liabilities= ….times

Question 2

Explanation of current ratio

Answer 2

It gives an indication of liquidity by showing how many
times the current liabilities are covered by the current assets

Question 3

Quick ratio

Answer 3

Current assets - inventory / current liabilities= ….times

Question 4

Explanation of quick
ratio

Answer 4

A better test of immediate liquidity,
It removes inventory which can take time to sell and corvert into cash

Question 5

Trade receivables payment period

Answer 5

(Receivables/ Credit sales)x 365= …..days

Question 6

Trade receivables payment period

Answer 6

(Receivables / Revenue ) x 365= …… days

Question 7

Explanation of trade receivables payment period = ….days

Answer 7

Shows the average number of days receivables pay take to pay
Show how quickly we can get the money from our customers

Question 8

Trade payables payment period

Answer 8

(Payables / credit purchases ) x 365= …..days

Question 9

Trade payables period payment

Answer 9

(Payables/ COGS ) x 365= …..days

Question 10

Explanation of trade
payables payment period

Answer 10

Shows the average days the business takes to pay their
credit suppliers

Question 11

Explanation of working capital cycle

Answer 11

It measures how long a business needs to fund its purchases of goods
the longer cycle, the longer the business has to find
financing

Question 12

How to reduce the working capital cycle?

Answer 12

The company needs to reduce the amount of time items are kept in stock, reduce the theme it takes to collect debts from customers and
increase the time it takes to pay its suppliers

Question 13

Inventory holding period

Answer 13

(Inventory / COGS ) x365 = …… days

Question 14

Explanation of inventory holding period

Answer 14

Shows the average number of days inventory is
held before it is sold

Question 15

Operating profit margin

Answer 15

(Profit from operations/ Revenue) x 100 = ….. %

Question 16

Explanation of operating profit margin

Answer 16

It shows in our sales what profit we have got remaining after
we paid our operating costs
Falling margin may be due to increased costs of sales, sales
prices being reduced to increase market share

Question 17

Interest cover

Answer 17

Profit from operations / Interest charges= …..times

Question 18

Explanation of interest cover

Answer 18

Measures how easily the business can make its
interest payments out of profit

Question 19

Gearing ratio

Answer 19

Total debt/ total debt + total equity x 100 =….. %

Question 20

Explanation of gearing ratio

Answer 20

Measures the financial risk of the company, when assessing the
coldit status of a customer the credit controller will be concerned with their long-term stability

Question 21

What does high gearing mean in the business?

Answer 21

There will be less cash available in the business as the cash balance will have been reduced by high interest payments

Lenders are less likely to want to lend the company more money
so we should be cautious when granting credit

Question 22

Return on capital employed

Answer 22

Profit from operations (net profit) / Capital employed x100 = ….. %

Profit from operations / TALC

TALC = total assets less current liabilities

TALC= total equity+ non - current liabilities

Question 23

Explanation of return on capital employed

Answer 23

Measures how much profit is generated for every £ of assets employed
Indicates how efficiently the company uses its assets
Compares profits to the overall size of the business

Question 24

Gross profit margin

Answer 24

Gross profit /Revenue x 100 = …… %

Question 25

Explanation of gross profit margin

Answer 25

How profitable the trading activities of the business are

Question 26

What causes the fall in the gross profit margin ?

Answer 26

Increased cost Reduced volumes Lower selling price

Question 27

Current ratio - how we use them If a company can be granted credit

Answer 27

This ratio shows the amount of current assets in relation to the current liabilities and is a measure of the liquidity of the business. If the company has a ratio of 2:1 it means that for every £ 1.00 of current liabilities the company has £ 2.00 Of current assets. Therefore in theory the business is liquid

Question 28

Making less gross profit from its sales which could be....

Answer 28

Decrease in selling prices and/or an increase in the cost of sales

Question 29

Interest cover

Answer 29

Interest Cover is a key indicator that is often used by credit agencies and financial institutions to calculate how many times the operating profit can cover the interest payments Interest paid is covered by the profit from operations by .... times

Question 30

Current ratio

Answer 30

Higher current ratio indicates a better credit worthiness when assessing a potential credit customer

Question 31

Current ratio is ....

Answer 31

A crude measure of solvency

Question 32

Gross profit margin reduction - Why ?

Answer 32

The selling price has decreased or the cost of sales has increased

Question 33

The current ratio has fallen because

Answer 33

1) Increase in current liabilities 2) Decrease in current assets

Question 34

What has happened to the operating profit margin %?

Answer 34

The operating profit margin % has increased from 15.32% to 32.00%. ## Footnote The percentage has more than doubled, which means the company is generating more profit which in turn should improve liquidity.

Question 35

What has happened to the interest cover?

Answer 35

Interest cover has increased from 8.00 to 2.1 times. ## Footnote The operating profit excellent cover for finance costs, which again indicates higher liquidity.

Question 36

What has happened to the current ratio?

Answer 36

The current ratio has also increased from 1.03 to 2.00 times. ## Footnote The current ratio is a direct indicator of liquidity. It gives an indication of liquidity by showing how many times the current liabilities are covered by the current assets.

Question 37

What has happened to the gearing %?

Answer 37

Gearing has dropped from 65.22 to 46.67%. ## Footnote The company is now less reliant on external financing - and the finance cost of covering that financing- which means that an increase in the credit limit lessens credit risk for the company.

Question 38

What do the positive trends of all four performance indicators imply?

Answer 38

The trends of all four performance indicators are very positive and will greatly reduce the level of credit risk, meaning that a positive recommendation may be given to the Finance Director for the increase in credit limit from 50000 to 90000.00. ## Footnote Performance indicators: Operating profit margin %, Interest cover, Current ratio, Gearing %

Question 39

Current ratio - explanation Current ratio : 0.38 in 2007 Current ratio: 0.35 in 2006

Answer 39

The current ratio has been consistent between the two years, however, this may be considered low for this type of business at around 35p or 38p of current assets for every £ 1.00 of current liabilities

Question 40

Interest cover - reason of decrease

Answer 40

Decrease in operating profit margins

Question 41

Quick ratio

Answer 41

The business meets its current liabilities by its current assets without the need to convert inventories to cash

Question 42

Ebitda/ total debt

Answer 42

Operating profit + depreciation / total debt