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Flashcards in Ratios Deck (16):

Gross profit ratio (%)

Gross profit x 100%

Assesses the profitability of a company's core activity


Operating profit ratio (%)

Operating profit x 100%

Shows operating profit generates ad a percentage of sales


Return on capital employed ratio (%)

Operating profit x 100%
Capital employed

Where capital employed is Equity + Non-current Liabilities

Expresses a company's profit as a percentage of the amount of capital invested in the company


Current ratio

Current Assets
Current Liabilities

Usually 2:1

Measures a company's ability to pay short-term obligations


Quick ratio (acid test)

Current Assets - Inventory
Current liabilities

Usually 1:1

Measures a company's ability to meet short-term obligations using it's MOST LIQUID assets


Trade receivables collection period (days)

Trade receivables x 365

Measures how quickly cash is being collected from debtors


Trade payables payment period (days)

Trade payables x 365
Cost of sales

Measures how long it takes a company to pay it's trade payables


Inventory holding period (days)

Inventory x 365
Cost of sales

Measures the number of days inventories are held (on average)


Asset turnover ratio

Capital employed

Where capital employed is Equity + Non-current Liabilities


Measures the level of efficiency of the company's assessed to generate sales


Interest cover ratio

Operating profit
Interest expense

Measures the number of times that the interest payable for an accounting period could have been paid out of available profits


Gearing ratio

Non-current liabilities
Equity + Non-current liabilities

Measures the extent to which a company's long term funds have been provided by lenders


What should a firm do if either:
The current ratio is not 2:1 or
The quick ratio is not 1:1

If the current ratio and quick ratio is outside of this range then further investigation should be made by looking at the operating cycle


What are low, normal and high levels of gearing?

Low gearing - less than 25%
Normal gearing - 25% to 50%
High gearing - more than 50%


What are some issues with highly geared firms?

The higher the borrowing (gearing), the higher the financial risk

If a company has too much debt:
- May not be able to meet their interest payments when they are due
- May not be able to make the repayments when they are due
- May be spending too much on interest that there is nothing left to give back to the shareholders as dividends
- The company will find it hard to borrow any more money if gearing is too high


What is the main limitation of ratio analysis?

They are based on financial statements and are therefore only as good as the financial statements they derive from


What are other limitations of ratio analysis

- They don't provide answers - the analysis is based on assumptions. They only highlight unusual information that needs to be further investigated
- Can be difficult to find a suitable company to compare to
- The ratios need to be looked at as a whole rather than individually when analysing
- Directors may manipulate the figures in financial statements