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AcF100 - Financial Statement Analysis > Week 22 - Measures of Performance > Flashcards

Week 22 - Measures of Performance Flashcards

(54 cards)

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1
Q

What do ratios express?

A

A relationship between two numbers.

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2
Q

How is an accounting ratio calculated?

A

By dividing one financial statement (F/S) number by another number from the same financial statement.

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3
Q

Why are ratios useful in accounting?

A

They standardise information by controlling for size differences.

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4
Q

What does the use of ratios allow for in analysis?

A

Comparability (benchmarking).

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5
Q

What is cross-sectional analysis?

A

Comparing different companies at the same time using ratios.

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6
Q

What is time series analysis?

A

Comparing the same company over different periods using ratios.

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7
Q

Besides comparing firms or time periods, what else can ratios be compared to?

A

An absolute target or benchmark.

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8
Q

What are the four main categories of accounting ratios?

A

Measures of performance

Measures of working capital

Measures of solvency and liquidity

Measures of return on investment and risk

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9
Q

What do measures of performance assess?

A

How the company is performing financially, specifically the profits generated.

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10
Q

What do measures of working capital indicate?

A

The company’s ability to manage elements of working capital effectively.

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11
Q

What do measures of solvency and liquidity show?

A

The company’s ability to pay its liabilities as they fall due.

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12
Q

What do measures of return on investment and risk indicate?

A

The company’s ability to generate returns for shareholders and the level of company risk.

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13
Q

What do measures of performance tell us?

A

How well the company is doing financially.

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14
Q

In accounting, what does “performance” mean?

A

How efficiently a company is generating profit from its operations

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15
Q

What are the two main types of performance ratios?

A

Profit margins and returns.

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16
Q

What are examples of profit margin ratios?

A

Gross profit margin

Operating profit margin

Net profit margin

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17
Q

What is an example of a return ratio used in performance measures?

A

Return on Capital Employed (ROCE).

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18
Q

What is a decomposition of ROCE?

A

Return on Total Assets (ROA).

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19
Q

What are three terms that all refer to the same concept of income from selling goods or services?

A

Revenue = Sales = Turnover (UK term).

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20
Q

What is another term for finance cost?

A

Interest expense.

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21
Q

What are three terms that all refer to the bottom line of a company’s financial performance?

A

Profit or loss = Net income = Earnings.

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22
Q

What do margins tell us in accounting?

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A

Margins tell us about profit levels as a proportion of revenue.

23
Q

What does the gross profit margin measure?

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A

Profitability considering only direct costs of sales.

24
Q

How does gross profit margin help assess a company?

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A

Shows how much gross profit is made per £1 of sales.

Indicates the price premium a company commands for its products/services.

Reflects the efficiency of procurement and production processes.

25
What is the formula for gross profit margin?
Gross Profit Margin = (Sales - Cost of Sales)/ Sales x100%
26
What does the net profit margin measure?
A measure of profitability that considers all expenses.
27
How does the net profit margin help assess a company?
It indicates how efficiently a company is able to generate profit, considering financing and tax expenses.
28
What does Return on Capital Employed (ROCE) measure?
ROCE indicates how efficiently and effectively a company has utilised its assets.
29
How are assets financed in the context of ROCE?
Assets are financed through equity capital and/or debt capital.
30
What is the formula for calculating Net Capital Employed?
Net Capital Employed = Equity Capital + Debt Capital (Including ordinary and preference share capital, premium, retained earnings, and non-current liabilities) OR Net Capital Employed = Total Assets – Current Liabilities (based on the accounting equation)
31
What is the formula for ROCE?
ROCE = (Operating Profit/ Net Capital Employed) x 100%
32
Return on Capital Employed (ROCE) Example: J Sainsbury plc 2020
– Operating profit: £650m * First method – Ordinary share capital and reserves: £7,277m – Preference (perpetual) securities and convertible bonds: £496m – Non-Current Liabilities: £8,117m ROCE = 650/ (7277+496+8117) x 100% = 4.09% * Second method – Total assets: £27,937m – Current liabilities: £12,047m ROCE = 650/ (27937-12047) x 100% = 4.09%
33
How is ROCE decomposed?
By multiplying the numerator and denominator by Sales and reconfiguring.
34
What does the decomposition of ROCE look like?
ROCE = (Operating Profit/ Sales) x (Sales/ Total Assets-Current Liabilities)
35
What does the decomposition of ROCE result in?
ROCE = Operating Profit Margin x Asset Turnover Ratio
36
What is the expanded formula for ROCE based on decomposition?
ROCE = Operating Profit/ (Total Assets-Current Liabilities)
37
What does the Asset Turnover Ratio measure in the context of ROCE?
It measures a company’s ability to generate sales from its assets.
38
What does the Asset Turnover Ratio measure in the context of ROCE?
It measures a company’s ability to generate sales from its assets.
39
What does the Asset Turnover Ratio reflect?
It reflects the level of activity and productivity in utilising assets to generate sales.
40
Why do asset turnover ratios differ across industries?
Because different industries use different technologies and have varying asset utilisation practices.
41
How do retail and pharmaceutical industries differ in terms of asset turnover?
The retail industry typically has a higher asset turnover ratio due to faster sales cycles, while the pharmaceutical industry has a lower ratio due to longer production and development times for products.
42
What is the formula for ROCE after decomposing it into its components?
ROCE = Operating Profit Margin x Sales/ (Total Assets-Current Liabilities)
43
Decomposition of ROCE Example: J Sainsbury plc: 2020
– Sales: £28,993m – Total assets: £27,937m – Current liabilities: £12,047m Asset turnover ratio = 28993/ (27937-12047) = 1.83 times Calculation check: ROCE = Operating Profit Margin x Asset Turnover Ratio 4.09% = 2.24% x 1.82
44
What does Return on Total Assets (ROA) measure?
It measures how much profit a company can make from every £1 of assets.
45
What is the formula for ROA?
ROA = (Operating Profit/ Total Assets) x 100%
46
What is a limitation of ROA?
It does not take into account how the assets are financed (whether through debt or equity)
47
Return on Total Assets (ROA) Example: J Sainsbury plc 2020
– Operating profit: £650m – Total assets: £27,937m ROA = 650/ 27937 x100% = 2.33%
48
When calculating ratios involving balance sheet and income statement or cash flow statement numbers, what issue arises?
Whether to use year-end figures or averages over the year.
49
How is the average total assets calculated?
Average Total Assets = (Total Assets at Year End + Total Assets at Previous Year End)/ 2
50
Why might averages be preferred over year-end figures?
Averages are more representative of the asset level over the entire year.
51
What is important when choosing between year-end or average figures for ratio calculations?
Ratios must be computed consistently using the same basis throughout.
52
What is the formula for ROA when using average total assets?
ROA = (Operating Profit/ Average Total Assets) x100%
53
What can cause high profit margins?
Efficient cost management Effective pricing strategies
54
What does a high ROA or high ROCE indicate?
Strong asset or capital utilisation to generate profits Or a low asset base relative to profits

AcF100 - Financial Statement Analysis (9 decks)

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