Lesson 6 Flashcards
(23 cards)
What are financial ratios
A representation of numbers that show the state of a company’s finances
They are powerful tools to help summarize financial statements and the health of a company
Why are financial ratios useful
You can compare performance to competitors or internal benchmarks
This helps spot trends internally which could boost the development of the company.
The comparison with competitors help to see if you perform better or worse then them.
Which users are interested in financial ratios
External users: Financial analysts, retail investors, competitors and tax authorities
Internal users: Management team, employees, and owners
Should ratios be used in combination with each other or by themselves
It’s better to use several financial ratios together instead of just one, so you get a clearer picture of how a company is doing.
What is a profitability ratio
Measure a company’s ability to generate income relative to revenue, balance sheet assets, operating costs, and equity
The are most valuable when compared to similar companies or past periods
What are the 2 categories of profitability ratios
- Margin ratios:
show how much profit a company makes from its sales - Return ratios
show how well the company rewards its owners (shareholders)
What is gross profit margin ratio
Shows how much profit a company makes after covering the cost of goods, before other expenses.
Gross profit margin = (Gross profit/Sales revenue)*100
What is operating profit margin ratio
Shows how much profit is left after all business operating costs, but before interest and tax.
Operatingprofitmargin =(Operatingprofit/Salesrevenue)*100
What is capital invested
Total money put into the business by shareholders and lenders to run the company.
Capital Invested = Net Working Capital + Property, Plant & Equipment
What is capital employed
All the capital a company uses to generate profit (debt + equity).
Two ways to calculate:
Capital employed = Total Assets – Current Liabilities
Capital employed = Equity + Non-Current Liabilities
What is average long-term capital invested in a business
The average amount of long-term funding used in the business (usually equity + long-term debt) over time.
What is return on ordinary shareholders’ funds ratio
shows how much profit the company made for its ordinary shareholders, compared to how much those shareholders invested.
If ROSF is 5% it means that for every dollar of revenue generated, the company is earning 5 cents in operating profit
ROSF = Profitfortheyear − Preferencedividends / (Ordinary share capital + Reserves
What is the ordinary share capital
It’s the money raised by a company from selling ownership shares to investors
What are reserves
Reserves are the profits a company keeps instead of paying them out as dividends
Dividends: Portion of a company’s profits paid to its shareholders as a reward for owning shares.
What is return on capital employed ratio
ROCE shows how well a company uses its money (capital) to make profit
If ROCE is 5% it means that for every dollar of capital employed in the business, the company generated a return of 5 cents in operating profit
ROCE = Operating profit/Average capital employed*100
Where:
Operating profit = Revenue – Operating expenses
Capital employed = Equity*(shares + reserves) + non-current liabilities
Average capital = (Beginning+Ending capital)/2
What does it mean if ROCE is higher or lower than cost of capital
ROCE is higher than cost of capital: Good. The company is making more profit than it costs to invest.
ROCE is lower than cost of capital:
Bad. The company is not earning enough to cover what it costs to invest.
What are efficiency ratios
Used to try to assess how successfully the various resources of the business are managed
What are average inventories turnover period
Shows how many days, on average, inventory is held before being sold
Formula:
(Average inventory/Cost of sales)*365
Where:
Average inventory = (Opening+Closing inventory)/2
What is the average settlement period for trade receivables
Shows how many days it takes customers to pay the business after a sale on credit.
Formula:
(Average trade receivables/Credit sales revenue)*365
Where:
Average trade receivables = (Opening + Closing receivables)/2
What is average settlement period for trade payables
Shows how many days the business takes to pay its suppliers for purchases made on credit.
Formula:
(Average trade payables/Credit purchases)*365
Where:
Average trade payables = (Opening + Closing payables)/2
What is sales revenue to capital employed
Shows how efficiently the company uses its capital to generate sales
A higher number = better use of capital
Formula:
Sales revenue/(Share capital+reserves+non-current liabilities
What is sales revenue per employee
Shows how much revenue each employee generates
Formula:
Sales revenue/Number of employees
What is the relationship between Profitability and efficiency
By analysing both:
- Profitability ratios (how much profit is made)
- Efficiency ratios (how well resources are used)
You get a full picture of how healthy and well-performing the business really is
