Financial Ratio Analysis Lecture

Vocabulary practice flashcards covering formulas, interpretations, causes, and benchmarks for asset turnover, working capital ratios, gearing, and interest cover.

Asset Turnover

A ratio calculated as $\frac{\text{Revenue}}{\text{Assets}}$; a decrease indicates revenue has fallen or assets have risen, which can occur when newly purchased property, plant, and equipment have teething problems or are bought late in the year.

Inventory Holding Period

A ratio calculated as $\frac{\text{Inventories}}{\text{Cost of Sales}} \times 365$ that measures how many days on average an item of stock sits in the warehouse before being sold.

Benefits of a Reduced Inventory Holding Period

Results in lower warehouse and storage costs, improved cash flow, and a lower risk of stock getting damaged or becoming obsolete (out of date).

Trade Receivables Collection Period

A ratio calculated as $\frac{\text{Trade Receivables}}{\text{Revenue}} \times 365$ that shows the average number of days taken to collect cash owed by customers.

Bad Debts

Debts that are unlikely to be recovered because customers cannot pay or go bankrupt, a risk that increases when credit periods are prolonged.

Causes of an Increased Receivables Collection Period

Poor credit control, such as failing to issue invoices promptly and not chasing debtors, or a deliberate business strategy to increase sales by offering extended payment terms.

Trade Payables Payment Period

A ratio calculated as $\frac{\text{Trade Payables}}{\text{Cost of Sales}} \times 365$ that measures the average number of days taken by a company to pay its suppliers.

Causes of an Increased Trade Payables Period

Cash flow shortages resulting from a lack of sales that force reliance on a bank overdraft, or the successful negotiation of favorable credit terms with suppliers.

Gearing

A ratio calculated as $\frac{\text{Bank Loans}}{\text{Bank Loans} + \text{Equity}} \times 100$ that expresses the proportion of total raised capital that consists of debt.

Financial Risk in Gearing

The increased difficulty and expense of raising additional capital, specifically requiring higher interest payments, caused by greater reliance on debt.

50% Plus Gearing Benchmark

The threshold at which banks and lenders start to become concerned about a company's debt level and take a closer interest in its financial position.

Interest Cover

A ratio calculated as $\frac{\text{Operating Profit}}{\text{Finance Cost}}$ that measures the safety margin between a company's operating profit and its interest payments.

2 to 3 Times Interest Cover Benchmark

The safety margin level where banks and lenders begin to get concerned and start asking questions about a company's ability to cover its interest obligations.