Flashcards in SU3 - The Analysis of Financial Statements Deck (34):

1

## Explain the purpose of Profitability ratios.

### It allows the analyst to evaluate the effectiveness and efficiency of the firm's management and employees in generating profit by means of sales, and the productive use of assets and of the capital of the owners.

2

## What are the typical profitability ratios?

###
1. Gross profit margin

2. Net profit margin

3. ROI

4. ROA

3

## Formula for Gross Profit Margin

### (Sales - Cost of Sales) / Sales x 100

4

## Purpose of the Gross Profit Margin.

### It indicates how well a firm is able to cover its operating expenses through its core business.

5

## What can be done to improve the Gross Profit Margin?

###
1. Increase sales through improved marketing.

2. Procurement and material managers could lower the levels of inventory.

3. Attempt to produce at a lower cost or to buy at better prices.

4. Produce fewer quantities or by less stock during periods of declining sales.

6

## What is the purpose of the Net Profit Margin?

### It measures the percentage of rand of sales remaining after all expenses, including taxes, have been deducted.

7

## The formula for Net Profit Margin.

### Net profit after tax / Sales x 100

8

## What can be done to improve the Net profit margin?

###
1. Increase sales through more efficient and effective marketing.

2. Reduce expenses

9

## What is the purpose of the ROI?

###
It measures managements effectiveness in generating profits with available assets.

It can be compared with the firms Required rate of return(Cost of capital), which it needs to exceed.

10

## The formula for ROI?

### Net Profit after Tax / Total Assets x 100

11

## What can be done to increase the ROI?

###
1. Increase revenue by increasing sales or the price of goods and services.

2. Lower operating expenses.

3. Reduce the investment in current assets, such as inventory and accounts receivable during periods of declining sales.

4. Evaluate the effectiveness and efficiency of the fixed assets with a view to improving productivity.

5. Improve the effectiveness and efficiency of employees through training.

12

## What is the purpose of the return on equity?

### It measures the returned earned on the owner's investment.

13

## The Formula of ROE?

### Net profit after tax / Shareholders equity x 100

14

## Explain the term Leverage or Gearing.

### it is the extent to which debt is used to finance the firm.

15

## What can be done to increase the ROE ratio?

###
1. Increase revenue by increasing sales or the price of goods and services.

2. Lower the operating expenses.

Improve marketing to improve the asset turnover rate.

3. Increase the leverage by making greater use of debt to finance the firm.

16

## Provide the 3 Liquidity ratios.

###
1. Net working capital

2. Current ratio

3. Quick (acid-test) ratio

17

## The formula for Net working capital.

### Net working capital = current assets - current liabilities

18

## How can Net Working Capital be improved?

###
1. Accelerate cash inflows by offering cash discounts for early settlement of debtor's accounts.

2. Buy fewer goods on credit in order to reduce the current liabilities.

3. Decrease inventory by selling more goods - improve sales and increasing cash or accounts receivable.

4. Increase current assets by increasing the level of ending inventory, as long as the inventory can be sold soon after the commencement of the new accounting period.

19

## Formula for the Current Ratio.

### Current Assets / Current Liabilities

20

## What does and Current ratio of 1.33 means?

### It means that you only have R1.33 in current assets of every one rand you have in current liabilities.

21

## What can be done to increase the Current ratio?

###
1. Accelerate cash inflow by offering cash discounts of early settlement of debtors' accounts.

2. Buy fewer goods on credit in order to reduce the current liabilities.

3. Decrease inventory by selling more goods.

4. Increase current assets by increasing the level of ending inventory, as long as the inventory can be sold soon after commencement of the new accounting period.

22

## The formula for the Quick (acid-test) ratio.

### (Current assets - inventory) / Current Liabilities

23

## The formula for Asset Turnover.

### Sales / Total Assets

24

## Provide the 3 Activity Ratios

###
1. Inventory turnover

2. Average Collection Period

3. Average Payment Period

25

## Formula for Inventory turnover

###
Cost of goods sold / Average inventory

Average inventory = Beginning inventory + Ending inventory

26

## Formula for ACP.

### Accounts receivable / Average daily sales

27

## Formula for APP

###
Accounts payable / Average daily credit purchases

Purchases is usually a percentage of cost of goods sold, which will be given.

28

## Formula for Debt ratio

### Total Liabilities / Total Assets x 100

29

## Formula for Debt-equity ratio

### Long-term debt / Shareholder's equity x 100

30

## Formula for EPS

### (Earnings after tax - preference dividends) / number of ordinary shares.

31

## Formula for Dividend per share (DPS)

### Dividends for ordinary shareholders / number of ordinary shares issued

32

## Formula for Price-earnings ratio (P/E ratio)

### Current market price of ordinary shares / EPS

33

## Formula for Earnings Yield

###
EPS / current market price x 100

Indicates the current income-producing power per ordinary share

34