Flashcards in Ratios Deck (16):

1

## Gross profit ratio (%)

###
Gross profit x 100%

Revenue

Assesses the profitability of a company's core activity

2

## Operating profit ratio (%)

###
Operating profit x 100%

Revenue

Shows operating profit generates ad a percentage of sales

3

## 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

4

##
Current ratio

###
Current Assets

Current Liabilities

Usually 2:1

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

5

## 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

6

## Trade receivables collection period (days)

###
Trade receivables x 365

Revenue

Measures how quickly cash is being collected from debtors

7

## 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

8

## Inventory holding period (days)

###
Inventory x 365

Cost of sales

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

9

## Asset turnover ratio

###
Revenue

Capital employed

Where capital employed is Equity + Non-current Liabilities

x:1

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

10

## 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

11

## 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

12

##
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

13

## What are low, normal and high levels of gearing?

###
Low gearing - less than 25%

Normal gearing - 25% to 50%

High gearing - more than 50%

14

## 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

15

## 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

16