Monitoring the Business: Ratios

Question 1

Who uses Financial Information?

Answer 1

1. Management
2. Shareholders
3. Banks
4. Trade Unions
5. Competitors
6. Suppliers
7. Employees
8. Government

Question 2

Management

Answer 2

• They will want information to know how the business has performed over the year and to learn if any changes are needed. This will help make decisions if needed

Question 3

Shareholders

Answer 3

• They will want to know if the money that they have put into the business has been used wisely by the firm in order to generate profits and pay them a dividend
• They want to know how much they can expect in dividends and they also want to know the value and security of their investment

Question 4

Banks

Answer 4

• They want to know if the business is profitable enough to be able to make loan repayments and interest repayments

Question 5

Trade Unions

Answer 5

• They will keep an eye on the company’s profits because if they know the business is doing very well, they may look for wage increases. They are interested in the security of employment and the future prospects of the company (will it expand and take on more workers, what are the promotion prospects of the workers)

Question 6

Competitors

Answer 6

• They will examine a business’s sales and profits to see how big a threat the business is to them

Question 7

Suppliers

Answer 7

• These are interested in a business’s accounts in order to assess the firm’s credit-worthiness. I.e. can the firm can pay for goods supplied on credit?

Question 8

Employees

Answer 8

• Will want to see if the firm is performing well for job security and promotion prospects

Question 9

Government

Answer 9

• Will want to see the performance of the firm to assess how much tax it owes

Question 10

Trading Account

Answer 10

• The trading account shows the sales, purchases, cost of sales and gross profit of the firm.
• Its main function is to find the gross profit or gross loss a firm made from actually buying and selling goods.
• Sales – Cost of Sales = Gross profit

Question 11

Sales

Answer 11

This is how much a business sold its products for

Question 12

Cost of Sales

Answer 12

Opening Stock + Purchases – Closing Stock

This is the cost of buying and making the products.

Question 13

Gross Profit/Loss

Answer 13

This is the difference between sales and cost of sales.

It is the profit/loss made before any expenses are made.

Question 14

Profit and Loss Account

Answer 14

gives the Net Profit/Loss- the profit after income has been added and expenses have been taken away.
• The profit and loss account shows the total expenses, such as insurance, rent and rates, light and heat, wages, etc.
• It also shows the dividend paid to shareholders and the retained profit for the year.
• Gross Profit + Income - Expenses

Question 15

Fixed Assets

Answer 15

These are possessions which a business owns for a long period of time (greater than one year).
eg.: land, buildings, premises

Question 16

Current Assets

Answer 16

These are short term assets which we own for less than one year.
e.g.: stock, bank, cash

Question 17

Current Liabilities

Answer 17

Liabilities are all debts that are owed by a business/person and which must be repaid in less than one year.
e.g.: creditors, bank overdraft

Question 18

Working Capital

Answer 18

Current Asset – Current Liabilities

This measures the liquidity of a firm

Question 19

Financed By

Answer 19

This is the amount of money invested or put into a business

eg.: long term liabilities, share capital, retained earnings

Question 20

Long-Term Liabilities

Answer 20

These are debts which will have to be repaid in the long term
I.e. in over one year

Question 21

Share Capital

Answer 21

This is the money invested (put into) a business by its owners (shareholders). It is made up of

i. Authorised Share Capital
ii. Issued Share Capital

Question 22

Authorised Share Capital

Answer 22

This is the maximum amount of money a company can raise from selling shares.

Question 23

Issued Share Capital

Answer 23

This is the actual amount of money that has been raised from issuing shares.

Question 24

Retained Earnings

Answer 24

These are a firm’s savings.
These are a firm’s profits which have been put aside and left to build up over the past number of years. These can be re-invested in the business in the future and used to help it expand.

Question 25

Profitability

Answer 25

The profit earned by the business

Question 26

Liquidity

Answer 26

The ability of the firm to pay its short term debts as they fall due

Question 27

Gearing (debt/equity

Answer 27

Examines the types of long term capital being used by the firm

Question 28

Profitability Ratios

Answer 28

1. Gross Profit Margin
2. Net Profit Margin
3. Return on Investment/Return on Capital Employed

Question 29

Gross Profit Margin

Answer 29

Gross Margin (Gross Profit Percentage)

Gross Profit x 100 = %
————– ———-
Sales 1

Question 30

Net Profit Margin

Answer 30

Net Profit X 100 = %
———— ————
Sales 1

Question 31

Return on Investment (ROI) or Return on Capital Employed (ROCE)

Answer 31

Net Profit X 100 = %
————- ———
Capital Employed 1

Question 32

Liquidity Ratios

Answer 32

1. Current Ratio/Working Capital Ratio

2. Acid Test/Quick Ratio

Question 33

Current Ratio/ Working Capital Ratio

Answer 33

The IDEAL figure should be 2:1.

Current Ratio = Current Assets : Current Liabilities

Question 34

Acid Test Ratio

Answer 34

The ideal figure is 1:1

Acid Test Ratio: Current Assets- Closing Stock: Current Liabilities

Question 35

Debt/Equity Ratio / Gearing Ratio

Answer 35

Debt Capital: Equity Capital

Loans: Retained Earnings + Issued Share Capital + Reserves