Interpretation of financial statements Flashcards
(22 cards)
What is the use of ratios?
Establish trends from previous years
Benchmark against other companies in same industry
Compare against industry averages.
What is the gross profit margin ratio?
Gross profit / Revenue x 100
What is the expense/revenue margin ratio?
Expense / Revenue x 100
What is the operating profit margin ratio?
Operating profit / Revenue x 100
Operating profit is before finance costs and tax
What is return on capital employed?
Operating profit / Total Equity + Non current liabilities x 100
What is the return on shareholders funds calculation?
Profit after tax / Total Equity x 100
Indicates the return the company is making on their funds ie: ordinary shares and reserves
What is the current ratio?
Current Assets / Current liabilites = x : 1
What is the acid test ratio?
Current Assets - Inventories / Current liabilities = x : 1
What is the ideal current ratio?
What is considered a low and high ratio?
2:1 meaning £2 of current asstes for every £1 of current liabilities
Too high - 3:1 - comapny has too many inventories, too many receivables or too few payables
Too low - > 1.5:1
What is the ideal acid test ratio?
1:1 - £1 of liquid assets to each £1 of current liabilities
A figure below 1:1 the company may struggle to pay its payables
What is the inventory holding period and inventory turnover caclulation?
IHD = Inventories / Cost of Sales x 365
IT = Cost of sales / Inventories
What is the trade receivables collection period calc?
Trade receivables / revenue x 365
What is the trade payables period?
Trade payables / cost of sales x 365
What is the working capital cycle?
Reveivables + Invenotry - Payables
What is the interest cover calculation?
Operating profit / finance costs (interest)
What is the gearing calculation?
Total debt (NCA) / Total debt (NCA) + total equity
If the current ratio is better than the industry average, what does this imply?
More current assets available to meet current liabilities so more solvent.
Higher trade receivables/ inventories
What are the limitations of analysis ratios?
Reliance on standards - Critising a company for having a low current ratio when the company sells the majority of its goods for cash and therefore has low trade receivbales
Inflation - comparions between years
Difference in accounting policies
Is a higher percentage for gearing than last year better or worse?
Worse - higher the ratio means more financially risky, might be down to obtaining additional loans during the year
Is a higher percentage for interest cover than last year better or worse?
Better - the higher the interest cover the better, argument for having some debt to help cash flows etc
If current ratio is worse than last year, why?
Fewer current assets available to meet its current liabilities
A low current ratio could indicate struggles to meet its current liabilities
Company is less solvent
May have more current liabilities
If gearing is better than last year, why?
Company less risky
Company might’ve repaid loans, or equity has increased from higher retained earnings or share issues
Interest payments will be reduced which would’ve helped return on shareholders funds
Lower gearing gives the company the ability to borrow in the future
