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Financial Reporting & Analysis 2 > Ratio Analysis > Flashcards

Ratio Analysis Flashcards

1
Q

what are some examples of benchmarks ratios can be compared to

A

prior year results
peers results
industry averages

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2
Q

how much can the ratios alone tell you about a company

A

about financial health

but indicates where needs further investigatioj

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3
Q

who are the users of ratios

A

users of financial statement same set

but certain ratios more useful for certain users

e.g. managers look at profitability ratios
lenders/borrowers look at liquidity ratios
investment analysts focus on investment ratios

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4
Q

what are the 3 categories of ratios

A

profitability ratios

liquidity and gearing ratios

investors ratios

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5
Q

what companies do investment ratios apply to

A

publicly listed companies

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6
Q

what do profitability ratios measure

A

how a company uses its assets to generate profitability

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7
Q

what is formula for gross profit margin

A

gross profit / revenue * 100 %

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8
Q

what does gross profit margin measure

A

how well our core operations are running

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9
Q

what could cause fluctuations in gross profit margin

A

change in what you charge

change in what you sell

possible incorrect inventory

change in costs

change in efficiency

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10
Q

what is the formula for operating profit margin

A

operating profit / revenue * 100%

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11
Q

what does operating profit margin measure

A

how we have controlled our overheads

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12
Q

what could cause fluctuations in operating profit margin

A

same as for gross profit margins, these effects will flow down

diminished control over operating costs

once off expenses e.g advertising campaigns, launching into new geographical area

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13
Q

what is the formula for return on capital employed

A

PBIT / (long term debt + equity) * 100%

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14
Q

what does return on capital employed measure

A

compares profit against the capital that was invested to make that profit

i.e. how efficiently they have been with their capital

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15
Q

why might there be fluctuations in ROCE

A

new assets not running at full capacity yet

older machines now have a reduced activity

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16
Q

what is the formula for return on equity

A

profit after tax and preference dividend / total equity * 100%

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17
Q

what does return on equity measure

A

potential return for ordinary shareholders

more relevant for shareholders as after tax and preference dividends = what they are entitled to

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18
Q

what could cause fluctuations in ROE

A

same as ROCE

gearing levels

tax impacts

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19
Q

what is the formula for asset turnover

A

revenue / capital employed

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20
Q

what does asset turnover measure

A

how well assets have worked to generate salesw

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21
Q

what is capital employed

A

equity and interest bearing debt

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22
Q

is it better to have a higher or lower asset turnover

A

higher

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23
Q

what could cause fluctuations in asset turnover

A

new assets bought late in year and no time for assets to generate any enhancement to profits

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24
Q

what is the difference between liquidity and gearing ratios

A

liquidity = ability to meet short term debts

gearing = ability to meet long term debts

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25
what is the formula for current ratio
current assets / current liabilities
26
what does the current ratio measure
ability to pay current liabilities out of our current assets
27
what is the formula for quick ratio
(current assets - inventory) / current liabilities
28
why does quick ratio exclude inventories
inventories are the least liquid current asset
29
what could cause fluctuations in current or quick ratio
change in receivables or payables seasonality
30
what is the target for current ratio
1.5 to 2 : 1
31
what is the problem with too low of a current ratio
cannot pay obligations
32
what is the problem with too high of a current ratio
storage and insurance cost for inventory, risk of it running obsolete money could be invested and put to better use elsewhere
33
if a company has no inventories what will the quick and current ratio be
the same
34
what is the target for the quick ratio
1:1
35
what is the formula for inventory turnover period
inventories / cost of sales * 365 days
36
what does inventory turnover period measure
number of days inventory held on average before being sold
37
is a higher or lower inventory days better
lower to minimise storage and security costs and risk of inventory running obsolete as long as it meets customer demand depends on the industry also
38
what could fluctuations in inventory days indicate
poor inventory control buying too much inventory and not selling enough low demand bought in bulk to avail of discount buffer stock due to unpredictable demand
39
what is the formula for receivables collection period
trade receivables / revenue * 365 days
40
what does receivables days measure
how long it takes to be paid by our trade receivables should bear in mind the credit term granted to customers
41
what could fluctuations in receivables days indicate
lower is better meaning money comes in quicker increased/decreased credit terms offered to customers don't want credit period to be too low as it will irritate customers to be constantly demanding them for money could indicate worse/better credit control
42
what is the formula for payables payment period
trade payables / purchases * 365 days
43
what does payables days measure
how long it takes to pay suppliers trade payables offer free short term finance but delaying payment risky
44
if there is no purchases figure on the accounts, what figure can be used instead to calculate payables days
cost of sales BUT REMEMBER TO BE CONSISTANT WITH THIS FIGURE WITH THE COMPARATIVE FIGURES
45
what causes fluctuations in payables days
changed credit terms if too low = bad reputation and losing out on potential discounts for paying early
46
what is the formula for debt equity ratio
interest bearing debt / equity * 100%
47
what does debt/equity ratio measure
long term financial stability and solvency
48
what are the benefits of a high debt equity ratio
tax shield of debt could be increasing to invest in positive NPV projects
48
what are the benefits of a low debt equity ratio
wriggle room to borrow more static
49
what are the risks of a high debt equity ratio
solvency risk could come into difficulty to repay debt
50
why can not every company use debt in their capital structure
1. need a stable history of profits, may be harder for newer companies 2. to borrow must have tangible assets for collatoral
51
what could cause fluctuations in debt equity ratio
share issue/share buyback repaying or drawing down new debt financing
52
what is the formula for interest cover
profit before interest and tax / finance costs
53
what does interest cost cover
how many times does our profit cover our interest payments
54
what is the target for interest cover
2 +
55
what could cause fluctuations in interest cover
factors that influence PBIT change in interest bearing debt
56
what is the formula for dividend yield
dividend per share / share price * 100%
57
what does dividend yield measure
what you get back compared to what you put in i.e. dividend you get compared to price you paid for share
58
what would cause fluctuations in dividend yield
changes in dividend paid changes in share price some stocks are growth stocks so don't pay dividends
59
what is the formula for dividend cover
profit after tax / dividends
60
what does dividend cover measure
compares profit available to be distributed among shareholders vs what was actually paid to shareholders
61
what could cause fluctuations in dividend cover
changing profit pressure to keep dividends year on year to keep shareholders happy
62
what is the formula for earnings per share
net profit per year / number of issued shareholders
63
what is the formula for price earnings ratio
share price / earnings per share
64
what does price earnings ratio measure
shareholders confidence in the company's future
65
what could cause fluctuations in price earnings ratio
change in profits change in sentiment from shareholders
66
what does an analytical income statement aim to do
seeks to work out NOPAT (net operating profit after tax) focus on operating activities, as these are critical and are hard to replicate compared to investing and financing activities
67
are analytical income statements published
no done by analysts
68
what is operating tax
tax with the tax shield of debt added back
69
what does an analytical balance sheet seek to find
invested capital
70
how is investment capital (investment perspective) calculated
operating assets - operating liabilities
71
how is investment capital (financing perspective) calculated
book value equity + Net interest bearing debt
72
why is cash excluded from net interest bearing debt
it is seen as surplus if it were needed for operations, it would have been spent already
73
what is the formula for return on invested capital
NOPAT / Invested Capital
74
what does return on invested capital measure
profitability of operations, disregarding how a firm is financed
75
what can ROIC be compared to
WACC of company (cost of capital) with competitors (benchmarking)
76
what type of growth for a business is the most attractive
recurring growth i.e. growing core business e.g. through efficiency, changing marketing approach, optimising invested capital, more profitable pricing
77
what type of growth is not that attractive for business
transitory growth i.e. once off so cannot rely on these going forward e.g. gains and losses on disposal, restructuring costs, change in tax rates, change in accounting policies
78
what are some limitations of ratio analysis
1. relies on historical info, changes may have occurred and no guarantee these results will continue into the future 2. accounts can be manipulated for desired effects 3. effects of related parties 4. seasonal trading can distort results due to levels of inventories, cash or receivables 5. asset acquisitions - some have not had the time to generate revenue 6. differences in accounting policies across companies makes comparisons difficult
79
what are some examples of 'creative accounting'
making provisions which are reversed post year end paying back loans just before year end and taking it back out again at beginning of year
80
what is the effect on the ratio analysis if the accounts were prepared just at the end of the entity's busy season
likely to have: - less inventory - more cash - more receivables not representative of the SOFP ratios for the whole year

Financial Reporting & Analysis 2 (8 decks)

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