Week 2 Flashcards
(25 cards)
What does an analysis of financial statements help with?
- set targets
- measure actual results
- compare actual results with goals
- take corrective actions if needed
What are the four groups of financial ratios?
- Liquidity ratios
- Solvency ratios
- Profitability ratios
- Activity ratios
What is liquidity ratios? What are the two ratios under it?
They are used as an aid to assess the liquify position of the business
1. Acid test ratio
2. Current ratio
What is the current ratio? What is the formula?
Current ratio indicates to what extent the current liabilities are coved by the current assets.
Current assets/current liabilities
What is the acid test ratio? What is the formula?
Business’s ability to pay off its current liabilities
Current assets - inventory/current liabilities
What does it mean if the acid test ratio is low?
- lack of sufficient cash resources
- too much inventory
- debtors already settled their accounts
What is activity ratios? What are the 3 types that fall under it?
Activity ratios gives and indication of how effectively the assets of the business are being used to make sales.
1. Inventory turnover rate
2. Debtors collection period
3. Creditors payment period
What is inventory turnover rate? What is the formula?
Gives an indication of how fast products are moving, relative to the cash flow.
Cost of sales/average inventory
How do you calculate average inventory?
Opening inventory + closing inventory/2
What does it mean if the inventory turnover rate is low?
- out of date inventory
- price too high on inventory
- wrong type of inventory
- carrying too much inventory
What does it mean if the inventory turnover rate is high?
- need less capital to carry inventory
- capital can be used more often to finance new inventory
- carrying too little inventory could lead to shortages
What is debtors collection period? What is the formula?
An indication of the number of days for the business to collect from it’s debtors
Average debtors x 360/credit sales
What is creditors payment period? What is the formula?
Gives an indication of the number of days to elapse before the business pays its creditors
Average creditors x 360/credit purchases
What is solvency ratios? What are the 2 types that fall under it?
The ability of the business to pay all its debts at any time
1. Debt ratio
2. Interest coverage ratio
What is debt ratio? What is the formula?
Reflects the extent to which the total liability are covered by its total assets.
Total assets/total liabilities
What is interest coverage ratio? What is the formula?
Indicates the number of times the business can pay its interest commitments for the year from its income before interest and tax
Income before interest and tax/interest commitments for the year
What is profitability ratios? What are the 4 types that are under it?
Reflects how profitable the available capital has been employed
1. Profitability of business
2. Profitability of own capital
3. Gross profit margin
4. Net income margin
What is profitability of the business? What is the formula?
The return that the business earns on the capital invested must meet the goals of the business
Net income before interest and tax x 100/total assets
The profitably of the business must:
- Excess inflation rate
- Be higher than alternative investments
- Be higher than interest rates
What is profitability of own capital? What is the formula?
An indication of the return that the owner of the business have earned on their capital annually.
Net income after interest and before tax x 100/own capital
What is gross profit margin? What is the formula?
Is calculates by expressing the gross profit as a % of the total sales of the year
Gross profit x 100/sales
How do you calculate gross profit?
Sales for the year - cost of sales
What is net income margin? What is the formula?
Directly influenced by the gross profit margin as well as operating expenses of the enterprise
Net income after interest and before tax x 100/sales
How do you calculate net income?
Gross profit - operating expenses
