7.2 Financial Ratio Analysis

What does it mean if a business has assets?

Assets are the items of value owned by a business

What does it mean if a business has liabilities?

Liabilities are money which a business owes

What is a non current asset ?

A long term resource expected to provide economic benefit for more than one year

Examples of non current assets?

• cars

• machines

• premises

What is a current asset?

Items which can be turned to cash within a year

Examples of current assets?

• product stock/inventory

• receivables

• cash

What is a non current Liability

• debts which a business is expected to pay within 1 year.

Examples of non current laibilities

• mortgages

• loans

What is a current liability?

Debts which have to be paid within a year

Examples of current liabiities?

• trade credit

• receivables

How to calculate ROCE?

ROCE = operating profit/total equity + non current liabilities (long term debts)

Where can operating profit be found in a question/figure?

can be taken from income statement

What is capital employed and how is it calculated?

total equity + non current liabilities

Where can capital employed be found in a question/figure?

can be found in a balance sheet

What is gearing ?

The extent to which a business finances its assets through borrowed funds compared to equity

How is gearing calculated?

Gearing = non current liabilities / capital employed

What are payables?

How often a business pays its suppliers

What are receivables?

How much money a customer owes to a company for goods and services which have been delivered but not paid for.

How to calculate payable days left (DPO)?

payable days / costs of sales x 365

How to calculate receivable days for a company to collect payment (DSO)

receivable days / revenue x 365

How to calculate Inventory turnover?

cost of sales / average inventory held

List the strengths/function of ratio analysis ?

• a tool which can be used to interpret a business’s accounts

• comparisons can be made over time

• data collected can also be compared to other businesses/rivals - dependent on weather information is public

Drawbacks of ratio analysis?

• overreliance on historical data

• unable to consider external economic factors/external non-economic factors like customer satisfaction

• differences in accounting policies

How to calculate average rate of return (AAR) ?

average annual return / initial cost of project x 100