Ratios

Question 1

Trade Payable Days

Answer 1

How many days averagely the business takes to pay its credit suppliers. If the figure for credit purchase is unavailable, use ‘Purchases’ figure. If that’s not available, use ‘Cost of Sales’

Question 2

Trade Payable Days 2

Answer 2

If the payable days is shown ad 40 days e.g -> the business averagely takes 40 days to pay for its credit purchases. An increase in this ratio= good for the business cash flow, although discounts may have been lost due to not paying promptly. Also, suppliers may be unwilling to keep supplying on credit if the figure is too high. Having this figure higher than receivable days would be good for cash flows as it means receiving cash from customers before having to pay suppliers

Question 3

How to reduce capital gearing levels

Answer 3

Additional share capital (not a bonus issue) and, if possible, share premium.
Increased retained earnings.
Increased revaluation reserve.
Sale of unwanted assets to repay NCL

Question 4

How to increase capital gearing levels

Answer 4

Buy back ordinary shares.
Convert short term debt into long term loans.
Issue preference shares or debentures

Question 5

Profit in relation to revenue

Answer 5

Profit for the year/ sales revenues x 100

E.g if the profit in relation to revenue = 15%
Profit for the year = revenue x 15%
Revenue = profit for the year / 15%

Question 6

What is total equity made up of?

Answer 6

Issued share capital + Capital Reserves + Retained earnings

Question 7

How would gross profit margin & Cost of Sales be used to calculate revenue

Answer 7

E.g COS = £120000 and GP= 20%.
If GP is 20% of revenue, then CoS must be 80% of revenue
Therefore , revenue = £120000/0.8=£150000
GP= £150000-£120000=£30000

Question 8

Liquid capital ratio

Answer 8

(CA- Inventory)/ CL : 1
Measures a business’ ability to meet its CL w/ it’s most liquid assets : cash & cash equivalents & trade receivables.
The ratio excludes stock as the business can’t be sure that all the stock will be sold

Question 9

Expenses in relation to revenue

Answer 9

Expenses/ Revenue x100
If the ERR is shown as 42%, -> 42p expenses for every £1 of revenue.
An increase = a business has been less able to control its expenses which is bad for profitability .
an increase in this ratio is a sign of decreasing financial efficiency

Question 10

How to improve liquid capital ratio

Answer 10

Reduce the amount of inventory being held , if necessary, by reducing the selling price of old inventory.
Additional long term borrowing (bank loans/ debentures).
Sale of unwanted NCAs

Question 11

Net profit margin (profit in relation to revenue) (P)

Answer 11

Profit for the year before tax/ Revenue x 100
If NPM is shown as 5% -> 5p profit for every £1 of revenue. An increase = higher profit in relation to the size of the business measured by revenue

Question 12

How to increase the NPM

Answer 12

Higher sales revenue w/o a larger increase in COS or expenses.
Higher gross profit margin w/o a larger increase in expenses
Lower expenses w/o decreasing sales revenue or gross profit margin

Question 13

Return on Capital Employed

Answer 13

If the ROCE is shown as 12% -> 12p profit for every £1 of capital employed. An increase in ROCE= higher profit in relation to the business size , as measured by capital employed.

Question 14

How to increase the ROCE

Answer 14

Higher sales revenue w/o a larger increase in the the COS or expenses
Higher GPM w/o a larger increase in expenses
Lower expenses w/o decreasing sales revenue or GPM

Question 15

Profitability ratios

Answer 15

GPM
Markup
Profit in relation to revenue (Net profit margin)
Return on capital employed

Question 16

Gross profit margin

Answer 16

GP/ Revenue x100
If the GPM is shown as 20% = 20p GP for every £1 of revenue.

Question 17

How to increase the GPM

Answer 17

Higher selling prices, w/o COS increasing
Lower purchase price w/o selling price decreasing
More efficient use of inventory, w/ less wastage, damage or theft

Question 18

Current ratio

Answer 18

If CR= 1.65 : 1 -> £1.65 CA for every £1 of CL. An increase in the CR means greater liquidity-> greater ability to pay CL when they’re due. However an excessively high CR suggests that the business has tied up CA unnecessarily

Question 19

How to improve the CR

Answer 19

Sale of unwanted NCA
Increase value of profitable sales
Additional long term borrowing/ turn its overdraft into a LT loan (reduces short term liabilities & increases capital)

Question 20

Mark up

Answer 20

If the M is shows as 50% = 50p gross profit for every £1 of COS

Question 21

How to increase the markup

Answer 21

Higher selling prices , w/o Cos increasing
Lower purchase price w/o selling price decreasing
More efficient use of inventory, w/ less wastage, damage or theft

Question 22

Liquid Capital Ratio

Answer 22

L’or shown as 0.85 : 1-> £0.85 liquid assets for every £1 of CL. An increase in LCR= greater liquidity= greater ability to lay CL when they’re due. However an excessively high LCR suggests the business hastied up liquid assets unnecessarily.

If the LCR is worsening but the CR is improving, = business is holding too much inventory

Question 23

Inventory turnover in days

Answer 23

If the inventory turnover in days is shown as 26 days -> a business holds stock for an average of 26 days. An increase in this ratio= bad for the business -> indicates lower sales and damages cash flow-> sign of decreasing financial efficiency

Question 24

How to improve inventory turnover (times/days)

Answer 24

Reduce the amount of stock being held , w/o decreasing sales.
Increase the sales levels (e.g better advertising or lower selling prices) w/o increasing the level of inventory

Question 25

Profitability ratios

Answer 25

GPM and Markup —>examine the relationship between selling price and the cost of buying or producing the goods that are sold . They don’t analyse the final profit made by a business . Profit in relation to revenue & ROCE examine the final profit made by a business

Question 26

Limitations of using ratio analysis to assess business performance

Answer 26

Window dressing Average ratios may not be reliable Ratios only focus on numbers Ratios don’t show the cause of the performances

Question 27

Current Ratio ( L)

Answer 27

Compares all of the business’ current assets with its current liabilities (Liquidity ratios are always expressed as X:1 ams to two decimal places)

Question 28

Rate of inventory turnover (times)

Answer 28

If the inventory turnover in times is shows as 3 -> business has gotten through (sold) its average inventory 3x during the year. An increase in this ratio = GOOD fore the business as it probably indicates higher sales and it certainly helps cash flow. An increase in this ratio is a sign of financial efficiency.

Question 29

Trade Receivable Days

Answer 29

How many days on average , credit customers take to pay for goods and services -> if credit sales figure isn’t available, use the Revenue figure

Question 30

Trade receivable days 2

Answer 30

If the receivable days = 35 days = on average credit customers take 35 days to pay for their goods. An increase in this ratio = bad for cash flow of the business & sign of decreasing financial efficiency. Also an increase in the likelihood of irrecoverable debts. A decrease in this fire may lead to a loss of customers due to tighter credit control, having this figure higher than payables days would be BAD for cash flow as it means laying suppliers before reviving cash from customers

Question 31

Dividend Per Share

Answer 31

The total dividend a company pays out over a 12 month period divided by the total number of issued shares- used by companies to calculate share profits with its shareholders. It can tell an investor about the company’s past financial health and its current financial stability. For example suppose company ABC had a dividend share of 60p last year but this year it doesn’t pay a dividend to its shareholders discount signal to investors. The company may be in poor financial health and cannot withstand the current market conditions decrease in dividend per share could cause investors to sell their stake in the company this the market value of ABC down. However a decrease does not always signal accompany is not financially stable for example suppose ABCD didn’t pay out a dividend with shareholders because it’s using its profit to reinvest into the company to create a new product. This reinvestment into the business can potentially produce higher dividends in the long-term. Suppose company has been paying a steady dividend of 90 people share the next year company a realise raises its dividend to £1.10 per share. This signals the company is financially stable and performing well and its market condition and increase in dividending per share also signals the management team is confident in the companies future profits.

Question 32

Dividend Yield

Answer 32

The amount of money a company pay shareholders over the course of a year for owning a share of its shareholding divided by its current stock price displayed as a percentage. It’s important for an investor concerned with wanting to generate an income from dividends however a higher dividend yield could indicate that a company is paying more of their profit out in dividends and not keeping as much profit as retained profit. If a company pays out large amount of dividends this may not be attractive to potential investors who may want to invest in a company to benefit from future growth. by paying out large amount of dividends i.e. a higher dividend yield would potentially reduce the market price of the share as there is less profit for future growth.

Question 33

Earnings Per share

Answer 33

Calculated as a companies profit divided by the number of ordinary shares its serves. It serves as an indicator of a company’s profitability. The higher a company’s EPS, the more profitable it is considered. The EPS shows how much profit a company makes for each of its shares. A higher EPS =more valuable = investors will pay more for a company with higher profits + attracts investors wanting to generate a short term medium income from their investment. However, comparing EPS in isolation = terms of one company against another may not have much meaning to investors because ordinary shareholders do not have direct access to the earnings. Instead investors will compare EPS with the SHARE PRICE of the shares to determine the value (potential) of earnings and how investors feel about future growth.

Question 34

Dividend Cover

Answer 34

Mention of an ability to pay dividends from its profits DC. DC shows an investor how many times the companies profits cover the dividends. A high DC = interests investor + shows that the company is more profitable. DC is used by investors to assess the risk of not receiving dividends, (a lower dividend cover is more of a risk ). A DC less than pay = that company doesn’t have sufficient profits to cover the dividends proposed to investors. However the company may still pay out dividends even if it’s dividend cover is less than 1 because it may be borrowing money to cover the dividend costs. This is a dangerous strategy as interest has to be paid on any borrowing.

Question 35

Price Earnings Ratio

Answer 35

Shows how expensive a share is to buy for an investor- how much an investor is prepared to pay for each £1 of the company’s profit. A higher PER = investors expects a high level of earnings in the future and that growth will be strong. The share price has risen faster than earnings on expectations of an improvement. A low= arises as share price falls -> the share price is cheaper (not good for an investor with shares looking for a long term investment). For some investors , high = attractive = high expectations for future growth. For others , low= expectations aren’t too high and the company is more likely to outperform earnings forecasts.

Question 36

Interest cover

Answer 36

How easily a company can pay its interest payments form its profits. The higher the number of times a company can cover its interest payments form its profits. The lower the IC , the more the company is burdened by debt expense. Companies need to have more than enough earnings to cover interest paintings in order to survive and financial hardships that may arise. Stability in IC ratios is one of the more important things to look forward when analysing interest cover coverage ratio in this way . Declining ICR = our company may be unable to pay in the future. Interest cover is a very good assessment of companies short term financial health.

Question 37

Capital Gearing

Answer 37

CG =65% —> 65p NCL for every £1 of capital employed. Anything above 50% —> a high level of CH= greater risk of the business not being able to afford the interest repayments. A high level of CG = banks are less willing to agree to further loans. Anything below 50% —> low level of CG= less risk of the business being unable to afford the interest and repayments. However a slightly higher one (yet still under 50%) = research and development However an excessively low level of CG =directors could be criticised for not using using NCL to improve the company’s performance.

Question 38

Indicators for Capital Growth

Answer 38

Each of the investor ratios would need to be compared with previous years. An increase in each ratio suggest a potential capital growth overtime. Increasing profits – share price changes are due to demand. Companies making increasing profits each year are likely to be in huge demand and therefore will see capital growth as the price of the shares increases in line with demand. Increased EPS compared to previous years. This would again suggest capital growth as increased payouts through dividends will see a rise in demand for the shares and therefore increased capital growth. A high price earnings ratio (can be overvalued by false confidence/mislead belief that the share price will grow) suggest a company will see an increase in earnings in future years. Whilst this is an excellent indication for future growth it must also be remembered that some shares have a ceiling in that there may be a limit to the amount of growth they can achieve. Compare the current market price with the share price high. Interest cover and gearing these ratios should be used to track/analyse the companies current position in relation to interest payments. Remember long-term liabilities incur interest and this will have a detrimental effect on profit.

Question 39

Define Dividend yield

Answer 39

The percentage amount paid per share return as a dividend Return on investment Short term

Question 40

Define price earnings

Answer 40

Tell us the true value of a share : share price valuation and open market if earnings per share were £1. For every £1 the share makes how much people are going to make

Question 41

Define interest cover

Answer 41

How many times you can pay interest out of profit The ability to pay out debts, take out loans gearing + interest cover

Question 42

Define earnings per share

Answer 42

Profit made/earned by each share

Question 43

Define dividend cover

Answer 43

How many dividends we can pay out with profit for the year?