POFM - comparative ratio analysis Flashcards by scarlet andrews

Q

Ratios in isolation are meaningless

A

o For ratios to be helpful in making informed decisions they must be compared to something
o i.e. find out their relative result, how do they compare to others

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Q

types of ratio analysis:

A

 with industry averages
 with results from other years
 with other businesses
 with industry leaders (benchmarking)

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Q

COMPARISON WITH INDUSTRY AVERAGES

Higher than average Liquidity

A

Good – more than enough CA to cover CL

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Q

COMPARISON WITH INDUSTRY AVERAGES

Higher than average Solvency

A

Bad – too much debt, risk and exposure to interest rates

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Q

COMPARISON WITH INDUSTRY AVERAGES

Higher than average Profitability

A

Good – earning more money than other businesses

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Q

COMPARISON WITH INDUSTRY AVERAGES

Higher than average Efficiency

A

Bad – less efficient than other businesses

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Q

COMPARISON WITH INDUSTRY AVERAGES

Below average Liquidity

A

Bad – not as much CA to cover CL

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Q

COMPARISON WITH INDUSTRY AVERAGES

Below average Solvency

A

Good – less debt, risk and exposure to interest rates

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Q

COMPARISON WITH INDUSTRY AVERAGES

Below average profitability

A

Bad – earning less money than other businesses

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Q

COMPARISON WITH INDUSTRY AVERAGES

Below average efficiency

A

Good – more efficient than other businesses

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Q

COMPARISON WITH PREVIOUS YEARS

Higher then last year Liquidity

A

Good – the business has improved their position

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Q

COMPARISON WITH PREVIOUS YEARS

lower than last year liquidity

A

Bad – the business performance has got worse

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Q

COMPARISON WITH PREVIOUS YEARS

Higher than last year Solvency

A

Bad – they have increased debt or reduced equity

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Q

COMPARISON WITH PREVIOUS YEARS

Lower than last year Solvency

A

Good – they have reduce their debt or increased equity

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Q

COMPARISON WITH PREVIOUS YEARS

Higher than last year Profitability

A

Good – they have become more profitable

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Q

COMPARISON WITH PREVIOUS YEARS

Lower than last year Profitability

A

Bad – they have become less profitable

Q

COMPARISON WITH PREVIOUS YEARS

Higher than last year Efficiency

A

Bad – they have become less efficient

Q

COMPARISON WITH PREVIOUS YEARS

Lower than last year Efficiency

A

Good – they have become more efficient

Q

Liquidity

Lower than 1:1

A

Not enough CA to cover CL. The business has liquidity problems and will not be able to pay their debts when they fall due

Q

Liquidity

Lower than the average

A

Less CA to cover CL than other businesses in the industry

The business may have liquidity problems and have difficulty paying their debts when they fall due

Q

Liquidity

Higher than the average

A

More CA to cover CL than other businesses in the industry.

The business is unlikely to have liquidity problems and difficulty paying their debts when they fall due

Q

ANSWERING LIQUIDITY QUESTIONS

A

o state what the ratio means in $ (how much CA for every $ of CL)
o compare to industry average (above or below? By how much?)
o comment on the ability of CA to cover CL (do they have enough?)
o comment on liquidity (ability to pay debts when they fall due) i.e. do they have liquidity problems and what are the consequences of this

Q

Solvency

Lower than 50%

A

The business is not using enough debt. As a result their profitability is reduced due to using to much equity. The business should use more debt

Q

solvency

Lower than the average

A

The business is lowly geared. The rely on equity finance.

Have good solvency, low levels of risk and are likely to be financially stable in the long term

solvency | Higher than the average

The businesses is highly geared. They rely on debt finance. | Have poor solvency, high levels of risk and ae likely to be financially unstable in the long term

ANSWERING SOLVENCY QUESTIONS

o state what it means in $ (how much debt for every $ of equity) o compare to industry average (above or below? By how much?) o comment on level of gearing (which type of finance does it rely on?) o comment on solvency position (long term stability) / level of risk due to exposure to interest rates

Profitability | Lower than the average

The businesses is less profitable. They either have lower sales, higher expenses or both

Profitability | higher than the average

The business is more profitable. They either have higher sales, lower expenses or both

ANSWERING PROFITABILITY QUESTIONS

o state what is means in $ (how much out of every dollar of sales is profit) o compare to industry average/ other businesses (above or below? By how much?) o for ROI also compare to the interest rate (it is above or below?) o comment on profitability position o offer possible reasons (if required)

efficiency | Lower than the average

The businesses is more efficient. They spend less money on the expenses due to less wastage or higher productivity they take less time to collect their accounts receivable

efficiency | higher than the average

The businesses is less efficient. They spend too much money on expenses due to wastage or low productivity. They take too long to collect their accounts receivable.

ANSWERING EFFICIENCY QUESTIONS

o state what it means in days (a/c rec turnover and $ (expense) o compare to industry average or credit terms (is it above or below? By how much?) o comment on efficiency (is it good or bad?)

ANSWERING RATIO QUESTIONS

1. state what the ratio means 2. compare the ratio to the average, previous year or rule of thumb 3. explain if the business is better or worse than the industry average, previous year or rule of thumb (say how much by) 4. link the outcome to the factor that you were analysing and explain what this means