Jan - Economics & Financial Reporting

Question 1

What is considered in the triple bottom line?

Answer 1

The triple bottom line (TBL) focuses corporations not just on the economic value they add, but also on the environmental and social value they add – and destroy.

Traditionally organizations measured success solely in terms of an economic bottom line – usually PROFIT

Question 2

How are aspects of the triple bottom line evaluated?

Answer 2

People (Social Bottom Line)
• Worker happiness
• Good employer

Planet (Environmental Bottom Line)
• “Life Cycle Assessment”
• “Environmental Impact”
• Human health

Profit or Prosperity (Economic Bottom Line)
• Capital and operating costs
• Wealth created

Question 3

What are CAPEX, OPEX, and TOTEX

Answer 3

CAPEX - investment costs

OPEX - operational costs inc. maintenance

TOTEX - total costs

Question 4

What are CCFDs?

What do they show?

Answer 4

Cumulative cash flow diagrams.

They represent transactions of cash which will take place over the course of a given project.

• Includes initial investments, operating costs, projected income (from sales), and salvage and resale value of equipment at the end of the project.
• Often used with a breakeven sheet and a balance sheet in order to see where money is being made or lost.
• Can be used to readily show the effect of changing variables on the project cash flow and compare different options.

Question 5

What are the financial considerations for starting a new project?

Answer 5

Level of Investment

• Land
• Buildings
• Capital Plant & Equipment

Annual Operating Costs

• Production costs (e.g. operators, raw materials, energy)
• Marketing costs (Sales team, advertising, exhibitions

Income
- Income, derived from Sales Revenue

Profit
Calculated for each year:
Profit = Income – Operating Costs

Tax
Paid each year on profit made, after deducting:
Depreciation tax allowances

Net Cash Flow (after tax)
Calculated from the above

Question 6

What are the 8 steps for a systematic approach to the economic evaluation of projects?

Answer 6

Step 1 - Calculate capital tax allowances
Step 2 - Calculate trading profits
Step 3 - Calculate taxable profits
Step 4 - Calculate tax receivable or payable
Step 5 - Calculate net cash flow after tax
Step 6 - Apply discount factor
Step 7 - Calculate present value of net cash flow
Step 8 - Apply chosen method of economic evaluation

Question 7

What is capital tax allowance a.k.a?

Answer 7

Depreciation tax allowance (not the same as depreciation of assets)

In the UK, allowances are applied to:
• Process Plant & Equipment
• Buildings (method depends on use)
• Land (normally excluded)

Question 8

What is capital tax allowance?

A.k.a depreciation tax allowance

Answer 8

It is tax relief on tangible capital expenditure, allowing it to be expensed against its annual pre-tax income.

If you buy an asset, for example, machinery or other equipment for use in your business, you cannot deduct your expenditure on that asset from your trading profits. Instead, you may be able to claim a capital allowance for that expenditure.
The aim is to give tax relief for the reduction in value of qualifying assets by letting you write off their cost over time against the taxable income of your business.

It’s a mechanism to pay less tax in the first years of a project. The government is stimulating investment, thus creating jobs and boosting the economy.

Question 9

What does NBV stand for?

Answer 9

Net book value.

Also known as net asset value, is the value at which a company reports an asset on its balance sheet. It is calculated as the original cost of an asset less accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.

Question 10

What is net book value?

Answer 10

Also known as net asset value, is the value at which a company reports an asset on its balance sheet. It is calculated as the original cost of an asset less accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.

Book value is equal to the cost of carrying an asset on a company’s balance sheet, and firms calculate it netting the asset against its accumulated depreciation. As a result, book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities.

Question 11

How are trading profits calculated?

Answer 11

Trading profit = income - operating costs

Additional important factors:
• Tax payable features in the next step.
• If we gain extra money from the sale of a Capital Asset this features as extra income.
• Therefore, this is added to our income calculations as we have to pay tax on this gain (none in this example).
• If we incur additional tax allowable costs (for tax calculation) at the end of project e.g. disposal of old plant & equipment (£20k in Year 5), then this is added to our operating costs in that year.
• On the calculation sheet – incomes are positive and expenditures (costs) are negative.

Question 12

How is tax allowance used?

Answer 12

Tax allowance is subtracted from profit.

The remaining value is the taxable profit, which you must pay tax on.

Question 13

What is tax payable?

How is it considered?

Answer 13

Tax which you must pay.

As the tax is normally payable in the ‘year following’ that in which the profit was earned, the amount of tax payable (or receivable) is entered one year forward in our Cash Flow calculations.
• Hence it is necessary to add an extra year in our table (year n+1), to allow for this ‘year following’ principle.
• Note: in reality, tax is often paid either in anticipation of a profit being made.

Question 14

How is the discount factor found?

Answer 14

= 1/ (1 + i/100)^n

Where:
i is the % internal rate of return (IRR)
n is the year for which the discount factor is calculated

Question 15

How do we select a suitable IRR (internal return rate)?

Answer 15

This is based on the normal level of return a company can expect to make from their investments. In our model:
• the IRR excludes any allowance for inflation,
• it allows for the payment of tax (IRR rate after paying tax).

Note: methods of calculation will vary between companies. Some may use a ‘before tax IRR’, and the calculation is adjusted.

Question 16

How is present value calculated?

Answer 16

PV = V(1/(1 + IRR)^n)

Where:
V I’d net cash flow after tax

IRR is the internal rate of return rate
n is the year for which the discount fa toe is calculated

Question 17

What is IRR?

Answer 17

Internal return rate.

IRR is the discount rate at which the present value of all future cash flow is equal to the initial investment or,
in other words, the rate at which an investment breaks even.

As a minimum:
i. IRR > (Savings Bank Rate – allowance for inflation)
Note: In our current financial crisis this would be a silly number.
ii. A higher IRR may be set to reflect the level of risk associated with the project.
iii. A higher IRR may be selected, to reflect high return investment opportunities e.g. overseas activities.

Question 18

What are the 3 main methods of economic evaluation?

Answer 18

1) Payback or break-even method
2) NPV method applying IRR to reflect the company’s after tax cost of capital
3) IRR method

Question 19

What does the payback or break-even method (regarding economic evaluation in a cash flow calculation) consider?

Answer 19

A fixed value of IRR is selected, and the number of years in which it takes for the cumulative PV to reach a value = 0, is calculated.

The project with shortest payback period would appear most attractive, but it would not necessarily be selected (as other factors are also considered).

Question 20

What does the NPV method (regarding economic evaluation in a cash flow calculation) consider?

Answer 20

A fixed value of IRR is selected, and the NPV for each project is calculated.

The project with the highest NPV would appear most attractive, but it would not necessarily be selected (as other factors are also considered).

A project with a negative NPV is unlikely to be selected (unless there are other strategic reasons e.g. safety requirement).

Question 21

What does the IRR method (regarding economic evaluation in a cash flow calculation) consider?

Answer 21

The NPV is calculated for different values of the IRR searching for a value of IRR such that the NPV = 0.

The project with the highest IRR would appear most attractive, but it would not necessarily be selected (as other factors are also considered).

Question 22

What are CAPEX and OPEX?

Answer 22

• Capital expenditure (CAPEX)

* Operational expenditure (OPEX)

Question 23

What must be considered when examining project costs?

Answer 23

CAPEX (captial expenditure)
OPEX (operational expenditure)
Cumulative cash flow
Life cycle cost
Whole life cost
Total cost of ownership
TOTEX

Question 24

How does a cumulative cash flow (vs time) diagram vary with increasing interest rate?

Answer 24

The gradient of the line of the production stages becomes steeper.

Question 25

What are the different stages of the cumulative cash flow (vs time) diagram? (A to H)

Answer 25

A-B: Development and design. CCF is negative since money is spent on development. B-C: Capital investment in buildings, land, plant, etc. CCF is negative. C-D: Working capital and plant commissioning. CCF is negative and typically at its lowest point (assuming profits are made effectively in the future). D-E: The plant starts to operate and some money is made. CCF is negative (but the line gradient is positive) E-F: Profits are made and CCF increases. Point F (on the x axis) is the break-even point. F-G: CCF is positive and profits are above costs. G-H: Period when income decreases and/or costs increase. Income slows but CCF is typically positive.

Question 26

What can be done to consider the uncertainties that arise with a cumulative cash flow diagram?

Answer 26

Don't stop with total cost of ownership (TCO) at the decision point. Continue monitoring the condition of assets and updating the total costs (engineering asset management).

Question 27

What is involved in asset management?

Answer 27

The consideration of asset capability and cost. Physical and financial models are produced to do so.

Question 28

What are the key elements of asset management?

Answer 28

- Alignment of assets and operations with corporate objectives - Asset management is about obtaining the knowledge needed to optimise trade-offs among financial performance, operational performance and risk exposure - Life-cycle costing is a key concept: Costs are minimized, starting with the initial investment, continuing through operation and maintenance, and ending with disposal - It is a process: To understand asset management, we need to identify and define the activities involved. Asset management is about designing and implementing a new business process that can deliver higher returns

Question 29

What is considered in TCO (total costs of ownership)?

Answer 29

``` Preparation, design, establishment, administrative Capital costs Maintenance Operation Revenues and/or cost savings Tax Financial risks of failure All converted to a net present value ```

Question 30

Give examples of users of financial information and how they use it:

Answer 30

Competitors: competitive analysis studies to look at market share Customers: ability to provide regular, reliable supply of goods, assessment of customer dependence Government: VAT and corporate taxation Lenders: capacity and ability to service debt and repay capital Employees: potential for providing continued employment Managers / directors: aid decision making Shareholders / investors: maintain a check on how effectively the company is run and to assess financial strength and future developments

Question 31

How do a cash flow sheet, balance, and profit and loss statements differ?

Answer 31

Cash flow - considers cash received and cash paid per time period (e.g. money in and out that week) Profit and loss aka income statement - specifically considers money made and lost Balance - considers assets, liabilities, equity. This links to the cash flow and income statements Balance Sheet • Financial snapshot at a moment in time. • Main elements: Assets; Liabilities; and Equity. Profit & Loss Account • Shows the change in wealth of the business over accounting period. • It measures the change in the balance sheet from one point to another. Cash Flow Statement • Cash is a crucial requirement for any business to develop. • Term cash also covers: deposits, overdrafts, etc.

Question 32

What is the prudence concept?

Answer 32

Revenue and profits are not anticipated, but only included when realised, or cash realisation can be assessed with reasonable certainty. Do not overestimate revenues or underestimate expenses. Be conservative in the reporting of assets and liabilities. Provisions for liabilities and expenses are made on information available rather than just guesses. Companies should record losses as soon as they are known, and profits only when they have actually been received.

Question 33

What is the accruals concept?

Answer 33

Revenue and costs are recognised as they are earned or incurred, are matched with one another and are dealt with in the PLA in the period to which they relate, irrespective of the receipt or payment. Revenues and costs are recognised as they are earned or incurred, and are dealt with in the income statement of the period to which they relate, irrespective of the period of receipt or payment. When transactions are recorded in the books of accounts as they occur even if the payment for that particular product or service has not been received or made, it is known as accrual based accounting.

Question 34

What is the consistency concept?

Answer 34

We have uniformity of accounting treatment of like items within accounting periods or from one period to the next.

Question 35

What are some of the main elements of a profit and loss account? (9)

Answer 35

``` Turnover Cost of sales Distribution costs Administration costs Other income Finance income Finance costs Taxation Dividends ```

Question 36

What do costs of sales include?

Answer 36

Cost of sales covers direct costs of goods sold plus any manufacturing expenses relating to the sales or costs of goods sold. E.g. cost of raw materials, packing costs etc.

Question 37

What do distribution costs include?

Answer 37

Distribution costs covers the cost of selling and delivering goods and services

Question 38

What do admin costs include?

Answer 38

All other costs not covered in costs of sales, distribution costs, or financial costs.

Question 39

What are distribution and administrative expenses?

Answer 39

Expenses not directly related to the production process but contributing to the activity of the company Include: • all expenses related to the normal operations of the company Exclude: • Expenses directly related to the manufacturing of the product (logistics department, quality department, …) • Share of overhead relating to manufacturing activities (heating, lighting, water, …) • Excluded financial expenses and revenues

Question 40

What does SOP stand for? What it SOP?

Answer 40

The Statement of Principles It is a statement of guidelines for determining the objectives of a person or organisation. ``` It identifies main users of financial information including: Investors Lenders Employees Suppliers Customers The Government The public ```

Question 41

What is the going on concept?

Answer 41

A boundary rule that assumes that the entity will continue in operational existence for the foreseeable future. This allows the historical costs of assets to continue to be used in the balance sheet on the basis of their being able to generate future income.

Question 42

What is the separate valuation concept?

Answer 42

A recording and measurement rule that relates to the determination of the aggregate amount if any item. To determine the aggregate amount, each individual asset or liability making up the aggregate must be determined separately.

Question 43

What is a purchase invoice and a sales invoice?

Answer 43

A purchase invoice records a purchase from a third party and represents an account to be payable at some time. A sales invoice records a sale to a third party and represents an account to be receivable at some time.

Question 44

What does an income statement show?

Answer 44

The profit or loss generated by an entity during an accounting period by deducting all costs from total sales

Question 45

What does a balance sheet show?

Answer 45

It discloses the assets (debit balances) and liabilities and shareholders' capital (credit balances), and profits (gains) or losses at a given date.

Question 46

What is OP? How is it found?

Answer 46

Operating profit = revenue + other income - COS (cost of sales) - distribution costs - admin expenses

Question 47

What are dividends?

Answer 47

A sum of money paid regularly (typically annually) by a company to its shareholders out of its profits (or reserves). Retained earnings are the profits remaining once dividends have been deducted.

Question 48

What is financial accounting? | Give examples of its uses and purposes?

Answer 48

Financial accounting is the field of accounting concerned with the summary, analysis and reporting of financial transactions related to a business. This involves the preparation of financial statements available for public use. It's used by: • Competitors: competitive analysis studies to look at market share • Customers: ability to provide regular, reliable supply of goods, assessment of customer dependence • Government: VAT and corporate taxation • Lenders: capacity and ability to service debt and repay capital • Employees: potential for providing continued employment • Managers / directors: aid decision making • Shareholders / investors: maintain a check on how effectively the company is run and to assess financial strength and future developments

Question 49

What 4 characteristics make financial information useful?

Answer 49

Understandability Relevance Reliability Comparability

Question 50

What is a profit and loss statement also known as?

Answer 50

An income statement

Question 51

How is gross profit calculated?

Answer 51

Gross profit = Sales Revenue - Cost of Goods Sold (or Cost of Sales)

Question 52

What is EBITDA?

Answer 52

EBITDA stands for Earnings before Interest, Tax, Depreciation, and Amortization. It is calculated by subtracting SG&A expenses (excluding amortization and depreciation) from gross profit.

Question 53

What are Depreciation & Amortization Expenses

Answer 53

Non-cash expenses that are created by accountants to spread out the cost of capital assets such as Property, Plant, and Equipment (PP&E).

Question 54

What are the main headings of an income (profit and loss) statement?

Answer 54

Revenues Direct operating costs / Costs of goods sold (COGS) Gross Profit (= Revenue - COGS) Indirect operating costs Operating Profit (= Gross profit - Indirect operating costs) Interest Pre-tax income (= Operating profit - Interest) Taxes Net income (= Pre-tax income - Taxes)

Question 55

What are direct and indirect operating costs?

Answer 55

Direct costs are expenses that directly go into producing goods or providing services, while indirect costs are general business expenses that keep you operating.

Question 56

How are inventory and costs of goods related?

Answer 56

Cost of Goods Sold (COGS) = (Beginning Inventory + Purchases) – Closing Inventory

Question 57

What are the main elements considered in a balance sheet?

Answer 57

Assets Liabilities Equity Total assets = Equity - Liabilities

Question 58

What are the 2 main formats of a balance sheet?

Answer 58

Horizontal (left column is assets, right column is equity and liabilities) Vertical

Question 59

Why are assets purchased?

Answer 59

To generate future benefits. They must be measurable in monetary units, and the business must have exclusive control over assets. Fixed assets include land, buildings, equipment, furniture, software, vehicles. Fixed assets are not renewed within the operating cycle These include tangible fixed assets, intangible fixed assets (e.g. patents), and financial assets.

Question 60

Give examples of fixed and current assets:

Answer 60

Fixed: land, buildings, equipment, furniture, software, vehicles Current: stocks, trade debtors, prepayment, cash (inc. amounts owed by customers)

Question 61

What are liabilities?

Answer 61

A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.

Question 62

Give examples of short and long term liabilities:

Answer 62

Short term: Items expected to become payable within one year from balance sheet date • Short-term financial debt (overdrafts, loans, leases) • Trade creditors or account payable (Suppliers of raw materials, VAT, national insurance, taxes) • Accruals (allowances made for costs and expenses incurred and payable within one year but for which invoices have not yet processed) Long term: • Creditors • Financial debt • Provisions (charges against profit for an expected liability or loss even though the amount or date is uncertain)

Question 63

What is a creditor?

Answer 63

A creditor is an entity (person or institution) that extends credit by giving another entity permission to borrow money intended to be repaid in the future. A business that provides supplies or services to a company or individual and does not demand payment immediately is also considered a creditor, based on the fact that the client owes the business money for services already rendered.

Question 64

What are the 3 elements considered by equity?

Answer 64

• Capital (total investment of shareholders in the company based on nominal value of share) • Premiums (e.g. share premiums: difference in price between the original nominal value and the price new investors will have to pay for new shares) • Retained earnings (Shareholders decide on dividends and amount reinvested)

Question 65

What are accruals?

Answer 65

Accruals are revenues earned or expenses incurred which impact a company's net income on the income statement, although cash related to the transaction has not yet changed hands. Accruals also affect the balance sheet, as they involve non-cash assets and liabilities. Accrual accounts include, among many others, accounts payable, accounts receivable, accrued tax liabilities, and accrued interest earned or payable.

Question 66

What are fixed assets?

Answer 66

An asset being held with the intention of creating wealth rather than being held for resale e.g. machinery

Question 67

What is a debenture?

Answer 67

The written acknowledgment of a debt by a company and normally containing provisions as to pay interest and the terms of repayment. A debenture might be secured on some or all assets of a company or its subsidiaries. A debenture is a loan agreement in writing between a borrower and a lender that is registered at Companies House. It gives the lender security over the borrower's assets.

Question 68

What are the key headings/aspects of an indirect cash flow statement?

Answer 68

Operating activities Returns on investment and servicing of finance Taxation Capital expenditure and financial investment Acquisitions and disposals Equity and dividends paid Management of liquid resources Financing

Question 69

What does SWOT consider?

Answer 69

Strength Weaknesses Opportunities Threats (S & W are internal influencers. O and T are external).

Question 70

What are the 5 different categories of financial ratios?

Answer 70

``` Profitability Efficiency Liquidity Financial Investment ```

Question 71

How is gross profit % found? | Profitability ratio

Answer 71

= gross profit / revenue = (revenue - cost of sales) / revenue

Question 72

How is profit for the year % found? | Profitability ratio

Answer 72

= net profit / revenue = (profit before tax - corporation tax) / revenue

Question 73

How are return on investments, ROI% found? | Profitability ratio

Answer 73

= operating profit / (total assets - current liabilities)

Question 74

How are debtor (collector) days calculated? | Efficiency ratio

Answer 74

= trade receivables (debtors) / revenue * 365 days Indication for average # days to receive payments from customers

Question 75

How are creditor (payable) days calculated? | Efficiency ratio

Answer 75

= trades payable (creditors) / cost of sales * 365 days Indication for average # days to pay suppliers

Question 76

How are inventory days calculated? | Efficiency ratio

Answer 76

= stocks / cost of sales * 365 Indication for average # stock is being held

Question 77

How are operating cycle (days) calculated? | Efficiency ratio

Answer 77

= inventory days + collection days - payable days Period of time which elapses btw cash being expended for production and collection of days from customer.

Question 78

How is asset turnover (times) calculated? | Efficiency ratio

Answer 78

= revenue / total assets Measurement of performance of company in generating revenue from assets under its control.

Question 79

How is current ratio (times) found? | Liquidity ratio

Answer 79

= current assets / current liabilities = overall measure for liquidity

Question 80

How is the acid test found? | Liquidity ratio

Answer 80

= (current assets - inventories)/current liabilities Ability of company to pay trades payables out of trades receivables in the short term.

Question 81

How is the defensive interval (days) found? | Liquidity ratio

Answer 81

(short term assets - stocks)/average daily cash from operations.

Question 82

How are gearing and interest cover found? | Financial ratios

Answer 82

Gearing = long term debt / (long term debt + equity) Contribution of long term lenders to long term capital structure of business Interest cover = profit before interest and tax / interest payable Number of times interest payable is covered by profit

Question 83

How are earnings per share found? | Investment ratio

Answer 83

= (profit for year - preference share dividends) / number of ordinary shares in issue

Question 84

How are dividends per share, dividend cover, and price:earnings ratio found? (Investment ratio)

Answer 84

Dividend per share = total dividends paid to ordinary shareholders / number of ordinary shares in issue. Dividend cover = earnings per share / dividend per share Price:Earning ratio = current share price / earning per share

Question 85

Regarding cash flow statements, suggest what is considered when calculating the costs of operating activities:

Answer 85

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. Considers factors like: - Operating profits (from profit and loss account) - Depreciation charges - Changes in stock values - Changes in debtors - Changes in creditors

Question 86

Regarding cash flow statements, suggest what is considered when calculating returns on investments and servicing of finance:

Answer 86

Factors such as: - Interest paid - Interest received - Income from investments

Question 87

Regarding cash flow statements, suggest what is considered when calculating capital expenditure:

Answer 87

Considers: - Tangible assets (land) - Intangible assets (patents) - Receipt of sales of fixed assets

Question 88

Regarding cash flow statements, suggest what is considered when calculating the management of liquid resources:

Answer 88

Liquid Resource means cash or those assets that may readily be converted to cash, such as a life insurance policy that has a cash value, stock certificates, or a guaranteed line of credit from a financial institution. Considers: - Purchase of government bills - Sale of government bills - Stock certificates - Stocks (shares) and bonds

Question 89

What are liquid resources?

Answer 89

Cash or those assets that may readily be converted to cash, such as a life insurance policy that has a cash value, stock certificates, or a guaranteed line of credit from a financial institution.

Question 90

Regarding cash flow statements, suggest what is considered when calculating financing:

Answer 90

The financing activity in the cash flow statement focuses on how a firm raises capital and pays it back to investors through capital markets. Examples: - Issuing of shares - Bank loans - Subsidiary loans

Question 91

What is a doubtful debt?

Answer 91

A debt for which there is some uncertainty as to whether or not it will be settled, and for which there is a possibility that it may eventually prove to be bad. A doubtful debt provision may be created for such a debt by charging it as an expense to the profit and loss account.

Question 92

Will the purchase of equipment show up on a profit and loss statement?

Answer 92

No. Assuming that the purchase of equipment is a long-term or noncurrent asset that will be used in a business, the purchase will not be reported on the profit and loss statement (income statement, statement of earnings). Instead, it will be reported in the balance sheet (under assets). The purchase will also be included in the company's capital expenditures that are reported on the statement of cash flows in the section entitled cash flows from investing activities.

Question 93

What are the 10 key steps of business performance analysis?

Answer 93

1. SWOT analysis 2. Consideration of major features e.g. geographical sectors, trends, information from auditors’ and chairman’s reports 3. Profitability e.g. return on capital employed 4. Efficiency e.g. debtor days, stock days 5. Growth e.g in sales, profits 6. Liquidity – short term solvency 7. Finance – long term solvency 8. Management of financial risk e.g. foreign currency exchange rates 9. Investment – is it sufficient to ensure future profitability 10. Conclusions

Question 94

What does solvency mean?

Answer 94

Solvency is the ability of a company to meet its long-term debts and other financial obligations. Solvency is one measure of a company's financial health, since it demonstrates a company's ability to manage operations into the foreseeable future. Investors can use ratios to analyse a company's solvency.

Question 95

How do current assets differ from inventory?

Answer 95

Current assets are balance sheet items that are either cash, cash equivalent or can be converted into cash within one year. Inventory is goods and items of value that a business holds and plans to sell for profit. This includes merchandise, raw materials, work-in-progress and finished products.

Question 96

Why use financial ratios?

Answer 96

• Benchmarking – rules of thumb define appropriate levels for individual financial ratios • Time-series comparison – comparison with companies own historical values • Cross-sectional comparison – comparison with ratios of competitors or industry averages • For a subjective assessment of the company or its constituent parts • For a more objective way to aid decision making • To provide cross-sectional analysis and inter-company comparison * To establish models for loan and credit ratings * To provide equity valuation models to value businesses * To analyse and identify under-priced shares and takeover targets * To predict company failure * They help compare different financial statements

Question 97

What are liquidity ratios?

Answer 97

Liquidity ratios are financial ratios used to determine a company’s ability to pay their short-term debt obligations. These ratios are a useful tool for relating different financial statements together. They also help a company determine whether they can use their current or liquid assets to cover their liabilities. Liquidity ratios reflect the level of health of the cash position of a company.