Financial Ratio Analysis

What is the purpose of financial ratios in business?

To assess the financial performance of a business.

How is Return on Capital Employed (ROCE) calculated?

(Operating profit ÷ total capital employed) × 100.

What is the formula for calculating capital employed?

Total equity + non-current liabilities.

What does the current ratio measure?

It measures a business's liquidity by comparing current assets with current liabilities.

How can the current ratio be calculated?

Current assets ÷ current liabilities.

What is measured by gearing calculations?

The proportion of long-term funding that comes from debt.

How is gearing calculated?

(Non-current liabilities / capital employed) × 100.

What are payables days used to calculate?

The time taken for a business to pay those it owes money to.

How can payables days be calculated?

(Payables ÷ cost of sales) × 365.

What do receivables days measure?

The time taken for a business to collect the money that it is owed.

How are receivables days calculated?

(Receivables ÷ revenue) × 365.

What is an advantage of using financial ratios for performance assessment?

Allows for comparison of performance across years.

What is a disadvantage of using financial ratios?

Does not consider non-financial information like changes in the external environment.

Give an example of how financial ratios might not reflect real risks.

A sole trader calculating performance ratios may not account for the risk of a competitor opening nearby.