Week 8 Ratios Flashcards
What are lenders interested in
liquidity and solvency ratios
what are shareholders interested in
profitability ratios and future share prices
What are the types of profitability ratios
ROCE
ROE
Operating profit margin, net profit margin
Gross profit margin
ROCE Formula and what is assesses
ROCE = operating profit (profit before interest) / share capital+ non current liabilities + reserves
assesses effectiveness of the total capital employed
ROE formula and what it assesses
ROE = profit for year less dividends / share capital + reserves
assesses return to shareholders
Operating profit margin formula and what it assesses
OPM = operating profit / sales revenue
measures operational performance
Gross profit margin formula and what measures
GPM = gross profit/sales revenue
measures directly trading performance
mark up formula and what it shows
mark up = gross profit / cost of sales
shows how much more a company’s selling price is than the amount the item costs the company
how to interpret profitability ratios
how do company’s returns compare to industry benchmarks?
Are margins consistent with the stated strategy?
Are the margins changing? Why?
What do efficiency ratios show
How long is inventory held
how long does it take customers to pay
how long does it take for the company to pay
how effectively does the company use its assets
Inventory days formula and measures what
inventory days = average inventories held/cost of sales x365 days
measures how long it takes on average for inventory to be sold (you want it to be as low as possible)
reasons as to why inventory days could be decreasing
sudden increase in demand
stocking up on inventory for holiday selling season or take advantage of trade discounts
receivables days formula and meaning
receivables days = average trade receivables/credit sales x365 days
shows how long on average credit customers take to pay the amount they owe to the business
payables days formula and meaning
payables days = average trade payables/creditpurchases x 365 days
shows how long the company takes to pay creditora
net asset turnover formula and meaning
NAT = sales revenue / share capital + reserves + concurrent liabilities
shows how effectively the entity uses its resources to generate sales
why does a business need working capital
retail - needs to buy and hold inventories
manufacturing - holds inventories of raw materials and part finished goods
what should be the aim of a company in terms of working capital
avoid excessive working capital which creates unnecessary cost
avoid having insufficient amounts of working capital as it can lead to difficulties with cash flow and liquidity
how to calculate operating cash cycle
average inventories holding period
+ average settlement period for receivables
- average payment period for payables
= operating cash cycle
problems with low receivables days
customers could go elsewhere to buy on credit since they don’t have a very long period of credit
what are liquidity and solvency ratios used for
credit risk analysis
what does liquidity show
short term ability to generate cash for working capital needs and immediate debt repayments
what do solvency ratios show
long term ability to generate cash internally or externally to satisfy capacity needs, fuel growth and repay debts
current ratio formula and measures
current ratio = current assets/current liabilities
you want this to be high
compares liquid assets of the company with its current liabilities
what is the acid test ratio formula and measures
acid test ratio = current assets - inventory / current liabilities
want this to be high
more rigorous measure of liquidity that excludes inventory
