3.7.2 Financial Ratio Analysis

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31 Terms

1

Balance sheet

A financial statement recording the assets and liabilities of a business on a particular day at the end of an accounting period

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2

Income Statement

This measure the business’ performance (income and costs) over a given time period

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3

What’s on a firm’s balance sheet?

  1. Assets

  2. Liabilities

  3. Capital

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4

Working Capital

The money a business has available to run it day-to-day operations

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5

Working Capital equation

Working capital = current assets - current liabilities

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6

Importance of working capital

  1. To pay for their day-to-day bills

  2. When there are significant time lags

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7

Usefulness of a balance sheet

  1. Compare different firms of the same size in the same industry

  2. Trend analysis

  3. Shows firm what they are able to afford

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8

Factors influencing a firm’s financial performance

  1. Economic climate

  2. New/strong competition

  3. Supplier/production/quality issue

  4. A change in the firm’s objectives

  5. Withdrawal from a market

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9

Window dressing

The manipulation of financial accounts by a business to improve the appearance of its performance

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10

Goodwill

Intangible assets that accounts for the excess purchase price of another company. E.g. brand loyalty and brand name

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11

Income statement

A historical record of a firms income and expenditure of a business over a period of time

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12

Gross profit

The profit made after costs of sales have been deducted from revenue

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13

Gross profit equation

Gross Profit = Sales Revenue - Cost of goods sold

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14

Operating profit

The profit made after admin and distribution costs have been deducted from gross profit

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15

Operating profit equation

OP = Gross Profit - Expenses

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16

Net profit before tax

The profit left after all expenses have been paid

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17

Net profit before tax equation

NPBT = OP - financial expenses

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18

Profit for the year

The profit the firm has left after tax has been deducted

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19

PFTY equation

PFTY = Profit before tax - tax

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20

Different types of ratio

  1. Liquidity ratios

  2. Efficiency ratios

  3. Profitability ratios

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21

Liquidity ratios

Refers to how easy the firm could pay all of its short term debts

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22

Current Ratio

Assesses whether a business has sufficient cash to be able to pay its short term debts

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23

Current Ratio equation

Current Ratio = Current Assets / Current Liabilities

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24

Improving Current Ratio

  1. Increase current assets

  2. Reducing trade credit terms

  3. Be ensuring that receivables are received quickly

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25

Acid test ratio

More severe test of firms capability to meet short term debts

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26

Acid test ratio equation

Acid test = (current assets - stock) / Current liabilities

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27

Inventory turnover

How many times in a trading year a firm sells the value of their stock

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28

Inventory turnover equation

IT = Cost of goods sold / closing stock

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29

Improving inventory turnover

  1. Sell off obsolete stock

  2. Introducing lean production

  3. Rationalise the product range to reduce stock-holding requirements

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30

Receivable days

How long it takes receivables to pay

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31

Receivables days equation

Receivables / sales revenue x 365

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