Ratio calculations and investment Flashcards
(95 cards)
1
Q
profitability (%)
A
type of profit/revenue X100
(gross profit)
(Operating profit)
(net profit)
2
Q
What is return on capital employed (ROCE)
A
measures profit generated by the business from assets owned by the business
3
Q
How to calculate return on capital employed (ROCE)
A
(operating profit/capital employed) X100
4
Q
Capital employed
A
total assets- current liabilities
5
Q
What are the two liquidity measures
A
current ratio
acid test ratio
6
Q
CURRENT ratio
A
current assets/current liability
7
Q
Acid test ratio
A
(current assets-stock)/current liability
Acid erodes stock
8
Q
Liquidity
A
the amount of cash a business has to cover its short term liability
9
Q
Gearing ratio definition
A
percentage of business assets bought using borrowed finance
The you need to buy gears using borrowed finance
10
Q
Gearing ratio calculation
A
(Non current liabilites/ capital employed) X100
11
Q
What is investment
A
spending on capital equipment used to make products
12
Q
Pay back calculation
A
- minus annual returns from investment to work out how many years it will take
- (Residual/ remaining payback) X12
13
Q
define payback
A
the amount of time it takes for an investment to repay its cost.
14
Q
disadvantages of payback
A
- based on future predictions.
2. is a short term calculation and doesn’t consider money made after payback period
15
Q
Average rate of return calculation
A
- add positive cashflows
- takeaway initial cost of investment
- divide by the lifespan
- calculate as a percentage of investment
16
Q
ARR definition
A
calculates the rate of return as a percentage of the investment
17
Q
negatives ARR
A
doesn’t consider the future value of cash
Ignores time
Focuses on profit rather than cash flow
Nit adjust for time-money
18
Q
Net present value calculations
A
- multiply each return by discount factor
- add all values up
- minus the cost of investment
19
Q
evaluation of investment appraisals
A
- the validity of the predictions (without past experience it may be biased)
- doesn’t account for external shocks
20
Q
what does theory suggest if the NPV is positive
A
the theory suggests that a business should go through with the project
21
Q
how to calculate contribution per unit
A
selling price- variable cost per unit
22
Q
break even calculation
A
fixed cost/ contribution per unit
23
Q
what is break even
A
the level of output needed for a firm to cover its costs
24
Q
limitations of breakeven
A
- assumes all stock is sold at the same price or one product
- doesn’t include bulk buying discounts
- variable costs are likely to change (COVID)
25
how to calculate variance
actual- budgeted
26
what is a favourable variance
when the differences in figures results in a positive outcome for the business.
EG when there are high revenues/lower costs than expected
27
What the ideal for a current ratio
1.5:1
| or 2:1
28
Whats the ideal for acid test ratio
1:1
29
what's the suggested gearing ratio when interest is low
25%. Firms can afford to have lowered gearing ratios as borrowing is cheaper
30
what does the current ratio and acid test ratio actually calculate
whether a firm has sufficient short-term assets to cover its immediate liabilities.
31
how to calculate capacity utilisation
(actual output/potential output) X100
32
what's the ideal capacity utilisation rate
theory suggests its 85%
33
Contribution calculation
revenue- variable costs
34
Contribution per unit calculation
selling price -variable costs per unit
35
Profit calculation using contribution
Profit= total contribution-fixed costs
36
Breakeven calculation
fixed costs/ contribution per unit
37
3 Breakeven advantage
1. can help decide if the business is viable
2. calculations are quick and easy
3. can support loans and application
4. may be motivational
38
Margin of safety
difference in business actual output and its breakeven output
39
what is an adverse variance
when the differences in figures results in negative outcome for the business.
EG when there are lower revenues/higher costs than expected
40
why does a business do variance analysis
to make budgets more accurate in the future.
41
Gross profit
Revenue-cost of sales
42
Operations profit
Gross profit- operating costs
43
Profit before tax
operations profit- interest
44
Payback
Time to an investment pays itself back
45
Payback benefits
Easy to calculate and understand the result
46
Payback drawbacks
Ignores cash flows after payback has been reached
May encourage short term thinking
Takes no account of the time value if money
Does not consider profitability in payback
47
Benefits of ARR
Simple understand and easy to calculate
Focuses on overall profitability of an investment
Easy to compare
Uses all returns generated by a project throughout
48
Net present value
Calculates the present value of future income from an investment , minus the cost
49
Purpose of budgets
Focus expenditures on company’s main objectives
No more is spent then the company expects
Measure of performance
Gives managers more responsibility - herzberg motivation
50
Types of budget
Historical budget - based on previous budgets with adjustments such as inflation
Zero-based budgets - based on justification of a manager (time consuming)
51
Variance analysis
Adverse - worse
| Favourable - better
52
Variance analysis managers
They can spot areas of significant variance through software such as excel
53
Budget variances occur because…
Original budget was unrealistic
The target was not met due to factors beyond the budget-holders control
The target was not met due to to factors within the budget-holders control
54
Difficulties of budgeting
Setting budgets - unrealistic targets but also avoid budgets creeping up
Agreeing or imposing budgets - imposing budgets is far less motivating and effective than giving than gibbing budget-holders a genuine say in setting targets, in agreement with senior managements
Failing to understand the causes of a budget variance - blaming budget holder is demotivating
The costs of the system outweighing the benefits - smaller businesses, single manager can keep control of finance without needing to set up budgets
55
Ways to improve profit
Increase revenue/selling price
- increase profit margin but may decrease overall profit - PED + SALES VOLUME
Decrease costs
- using cheaper materials or less labour can damage reputation therefore revenue
- only when an obvious source of waste is produced that a straightforward cut in costs happens
56
What document does all PLC have to produce to companies house
Statement of comprehensive income (balance sheet)
57
Cash flow and profit
Sales revenue does not equal cash inflow
| Costs do not equal cash outflows
58
Improving liquidity
Selling under-used fixed assets such as equipment or machinery
Raising more share capital
Increasing long-term borrowing through loans
Postponing planned investments
59
Managing working capital cycle
Ensuring there is enough cash in the cycle
| Making sure it moves through the cycle as quickly as possible
60
If capital cycle requirements are met then the following actions are likely to be used….
Control cash used
Minimise spending on fixed assets
Plan ahead for the next few months
61
Under-utilisation of capacity utilisation
Lead to fears for job security among staff, damaging motivation
Poor morale among managers
Contribute to a poor reputation for the business - empty tables restaurants
62
Over-utilisation of capacity
Unable to accept new orders, Turing away new customers to rivals
No time for maintenance on machines or train staff
63
Improving capacity utilisation
Increase current output
| Reduce maximum capacity
64
Swot analysis approaches
Top-down approach - external consultants
| Consultative approach - boss analyses whole business
65
Top-down approach + -
+ a dispassionate approach
+ detachment from company culture may shed light on business
- managers may fail to share all necessary info about business
66
Consultative approach + -
+ greater insight from a wider range of contributors
+ the chance for boss to gain first hand understanding of the whole business
- staff less likely to point out problems as it may reflect badly on them
67
Key performance indicators
```
Staff turnover
Like-for-like sales
Market share
Capacity utilisation
Unit cost
Brand recognition
Staff turnover
```
68
Opportunities and threats
```
Demography - adaptation
New laws and regulations
Technological factors
Competition - porters five forces
Commodity prices - increase/decrease
Economic factors - growth, inflation, tax, interest, unemployment and exchange rate
```
69
What do large businesses do (SWOT)
Lobbying - persuading MP’s to make decisions in bets interests of the business
70
PESTLE
```
Political
Economical
Social
Technological
Legal
Environmental
```
71
Political factors
Following Brexit
- less access to EU market
- import cost increase
- devalued pound
- less FDI
72
Economic factors
```
Inflation
Growth
Unemployment
Taxation
Exchange rate
Interest rate
```
73
Social factors
Trends
- eating healthy
- change attitude to smoking
- desire for convenience and service
- ageing population
74
Technological factors
New products
Lowered production costs
Changes can be a threat
75
Legal factors
New laws change structure and operations
76
Environmental factors
Pressure for ethical
Opportunity for USP
Adopting more efficient methods
77
What to do about external influences
Make the most of favourable factors
| Minimise impact of unfavourable factors
78
Posters five forces
```
Threat of new entrants
Threat of substitutes
Supplier power
Consumer power
Rivalry between competition
```
79
Intensity of comp is low
```
High barriers to entry
Few companies
Booming market
Branding high
No direct comp from abroad
Little spare capacity
```
80
Intensity of comp is high
```
equal size
Undifferentiated products
Slow market growth
Low capacity utilisation
Low barriers to entry
Faces comp from overseas
```
81
Threat of new entrants
Depends on barriers to entry within market
- patents
- branding
- high costs to customers of switching supplier = gas and electricity
- substational network infrastructure
82
Changes in the buyer power of consumers
Sells it product to many individuals it is favourable
Sells its product to few large customers it is unfavourable - economies of scale
Merges unfavourable
More expensive products and complex more favourable to business
83
Changes in the selling power of suppliers
Number of alternative suppliers
Uniqueness of suppliers product or service
Reliance on the business on technical support from their supplier
84
Threat of substitutes
How convenient and close substitute is
85
Five forces shape strategy
Adapt to changes
| Help business decisions - wiser and more effective
86
Quantitive sales forecasting helps
HR plan - no of employed
Cash flow forecasting - based on sales forecasting
Profit forecasts and budgets. - accurate sales forecast
Production planning - enough products and raw materials are available
87
Forecasting techniques used
Moving averages
Extrapolation - carry on the trend
Correlation - scatter graph
88
Limitations of quantitive force casting techniques
The future may not be the same as the past - external shocks/trends
The quality depends on the quality f the forecasters interpretations - pairing variables
89
Types of ratio
Profitability - relationship of profit and revenue with capital
Liquid - meet short term debts
Gearing - long term finance comes from loans
90
Reduce an unhealthily high gearing ratio
Issue more shares
Retain more profits
Repay some loans
91
Gross profit margin improve and too low
Price up
Unit variable costs down
May not be enough gross profit to cover overheads
92
Operating profits improve and too low
Boost gross profit margin
Cut overheads per £ of sales
Increase sales
May not be enough operating to reinvent into the business and so get growth
93
Net profit improve and too low
Boost operating profit margins
cut corporation tax bill legally
Too low to pay acceptable dividends
94
Boosting ROCE
Find a way to increase operating profit
| Reduce capital e,played without damaging operating profit
95
Limitations of ratio analysis
Limitations of ability to whole business story
Lack of detail within h financial accounts - stocks and receivables aren’t shown
If receivables figure is on balance sheet, will be misleading in the ratios
If stock is about to go out of fashion becoming worthless, current ratio will mislead
On profit and loss account, net profit cash be affected by one off payments such as selling property
Boosting net profit, improve the net margin for this year, might be a blip, misleading those who do not investigate further than the ratio
