InInterpreting Financial Statements

Question 1

What do ratios help with?

Answer 1

Comparisons between businesses of different sizes.

Question 2

What would you look at to see if a 20% return was a good or poor result?

Answer 2

Compare with:
- Same ratio from the past
- Budgeted/ planned ratio
- Similar Businesses
- Industry averages

Question 3

What are the categories of ratios?

Answer 3

Profitability, Efficiency and Liquidity

Question 4

What does the profitability ratios show?

Answer 4

What return from capital and assets.

Question 5

What does the efficiency ratios show?

Answer 5

Is the business making efficient use of its resources.

Question 6

What do the liquidity ratios show?

Answer 6

If there is enough short term cash and if the current obligations can be met.

Question 7

How is the gross profit margin calculated?

Answer 7

The gross profit divided by the revenue.

Question 8

What does the gross profit margin show?

Answer 8

The gross profit as a percentage of revenue.

Question 9

What does the return on capital employed show?

Answer 9

It shows PbIT as a percentage of capital employed.

Question 10

How is the RoCE calculated?

Answer 10

PbIT divided by the share capital+reserves+long-term loans

Question 11

What is the profit that operational managers have the most control over?

Answer 11

PbIT

Question 12

What is the operating profit margin?

Answer 12

The operating profit as a % of revenue

Question 13

How do you calculate the operating profit?

Answer 13

PbIT divided by the revenue

Question 14

What does the asset turnover show?

Answer 14

The revenue as a % of the capital employed. How many times the revenue was turned over in assets.

Question 15

What are the problems with the RoCE?

Answer 15

• Calculation methods can vary.
• Different analysts will calculate the ratio in different ways.
• Are assets valued at “current prices”?
• Capital investment often results in low returns in the early years.

Question 16

What do efficiency ratios show?

Answer 16

How well is a company using its resources (especially in the short-term)

Question 17

What is the inventory turnover period?

Answer 17

The average number of days inventory is held.

Question 18

How is the inventory turnover calculated?

Answer 18

Inventory divided by cost of sales

Question 19

What kind of inventory turnover is preferred?

Answer 19

A low one

Question 20

What is receivables collection?

Answer 20

How long credit customers take to pay their bills.

Question 21

How do you calculate the receivables collection?

Answer 21

Trade receivables divided by the credit sales (per day)

Question 22

What can be wrong with the receivables collection as a ratio?

Answer 22

It’s an average so one high or low value could distort it.

Question 23

What is the payables payment (Creditors)?

Answer 23

How long it takes to pay suppliers.

Question 24

How do you calculate the payables payment?

Answer 24

Trade payables/ cost of sales

Question 25

Whats wrong with the payables payment?

Answer 25

Its an average and so can be distorted by a high or low value.

Question 26

What is the working capital cycle a measure of?

Answer 26

The difference between payments made to suppliers and cash received from customers.

Question 27

What are the general rules for the WC cycle?

Answer 27

- WC cycle should be as short as possible - Shorter cycle = money is tied up in the WC for as little as possible. - This will reduce the amount of short-term capital required to operate.

Question 28

What does a decrease in the WC cycle mean?

Answer 28

Less money required to operate in the short-term which is usually a good sign, but the payables increase is the largest factor and may be risky.

Question 29

What is liquidity?

Answer 29

Ability to meet short-term obligations when due.

Question 30

What does the liquidity ratios show?

Answer 30

If there is enough short-term cash to pay bills. Banks, customers and suppliers are all interested in liquidity.

Question 31

How do you calculate the current ratio?

Answer 31

Current assets divided by the current liabilities.

Question 32

How do you calculate the acid-test ratio?

Answer 32

The current assets - the inventory divided by the current liabilities.

Question 33

WHat does a higher current ratio mean generally?

Answer 33

More liquidity