Analysing Published Accounts (A Level) (Cambridge (CIE) A Level Business): Flashcards
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Define liquidity.
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Define liquidity.
Liquidity is the ability of a business to pay back its short-term debts, such as money owed to suppliers.
What may happen if a business cannot pay its suppliers?
Suppliers may stop delivering raw materials or components, so production will be delayed.
A business that cannot pay its debts is considered _______.
A business that cannot pay its debts is considered insolvent.
How is the current ratio calculated?
The current ratio is calculated using this formula:
Current ratio = current assets ÷ current liabilities
The result is expressed as a ratio in the form ? : 1.
A business has current assets of $15,545 and current liabilities of $5,060. What is its current ratio?
The current ratio is 3.07 : 1, so the business has $3.07 of current assets to cover each $1 of short-term debt.
For which type of business is the current ratio an effective liquidity measure?
The current ratio is an effective liquidity measure for businesses that hold little inventory.
How is the acid test ratio calculated?
The acid test ratio is calculated using this formula:
Acid test ratio = (current assets − inventory) ÷ current liabilities
The result is expressed as a ratio in the form ? : 1.
True or False?
The current ratio is a more realistic measure than the acid test ratio of a business's ability to meet short-term debts quickly.
False.
The acid test ratio is more realistic because it removes the least liquid current asset, which often takes time to sell.
The acid test ratio is also known as the ____________ ratio.
The acid test ratio is also known as the liquid capital ratio.
How does reducing the credit period offered to customers improve liquidity?
Collecting money from customers more quickly increases current assets. However, customers may move to competitors that offer better credit terms.
True or False?
Asking suppliers for an extended repayment period does not reduce a business's current liabilities.
True.
Current liabilities are not reduced, but the business can use the cash it would have paid to suppliers for other purposes.
How does selling off excess inventory improve liquidity?
Less liquid inventory is converted into cash, a more liquid current asset, and storage and security costs may fall. However, the inventory may need to be sold at a low price.
True or False?
Using an overdraft improves liquidity without increasing current liabilities.
False.
An overdraft increases current liabilities, but it lets the business spend more money than it has in its bank account.
What is a drawback of bringing in new capital from additional investors to improve liquidity?
It may lead to the dilution of control of the business.
Define profitability.
Profitability is a measure of how effectively a business converts revenue into profit, or how well capital invested is used to generate profit.
How does profitability provide internal finance?
Retained profit can be reinvested in the business, which reduces the need for external borrowing.
True or False?
A profitable business is more likely to secure funding from investors and lenders.
True.
Profitability shows that the business can generate returns and repay debts, which makes it more attractive to fund.
How is return on capital employed calculated?
Return on capital employed (ROCE) is calculated using this formula:
ROCE = profit from operations ÷ capital employed × 100
Capital employed is calculated as issued shares + reserves + _____________________.
Capital employed is calculated as issued shares + reserves + non-current liabilities.
True or False?
ROCE results can be reliably compared between businesses in different industries.
False.
ROCE differs between industries, so it should be compared with businesses in the same industry or with other returns, such as interest rates on savings.
How is the gross profit margin calculated?
The gross profit margin is calculated using this formula:
Gross profit margin = gross profit ÷ sales revenue × 100
How might a falling gross profit margin affect a business's dealings with suppliers?
It can trigger talks to get better raw material prices or a switch to alternative suppliers.
How is the profit margin calculated?
The profit margin is calculated using this formula:
Profit margin = profit from operations ÷ sales revenue × 100
Changes in the profit margin show how well managers are keeping ______ costs low or encouraging sales.
Changes in the profit margin show how well managers are keeping indirect costs low or encouraging sales.
What are the two main ways to increase ROCE?
A business can make more profit without using more capital, or use less capital to make the same profit, for example by selling unused equipment.
How does raising prices improve the gross profit margin if costs stay the same?
The gap between the selling price and costs becomes larger, giving more profit per unit sold.
True or False?
Bulk buying raw materials to cut direct costs creates no extra costs for a business.
False.
Bulk buying may need more storage space, which could reduce the overall cost savings.
What is a risk of reducing staffing levels to cut overhead costs?
Reducing staffing levels may harm staff morale and reduce productivity.
Define financial efficiency.
Financial efficiency is a measure of how well a business uses its assets and liabilities to generate sales and maximise profits.
How does financial efficiency boost competitiveness?
A financially efficient business can keep prices lower or invest more in quality and innovation, giving it an edge over rivals.
How is average inventory calculated?
Average inventory is calculated using this formula:
Average inventory = (opening inventory + closing inventory) ÷ 2
How is inventory turnover calculated as a number of times?
Inventory turnover (number of times) is calculated using this formula:
Inventory turnover = cost of sales ÷ average inventory
How is inventory turnover calculated as a number of days?
Inventory turnover (number of days) is calculated using this formula:
Inventory turnover = (average inventory × 365) ÷ cost of sales
True or False?
A business should aim for a high or rising inventory turnover when it is measured in days.
False.
A business aims for a low or falling number of days, as selling inventory quickly means profit is achieved swiftly and obsolete inventory is less likely.
Businesses that sell large volumes of low-priced or ________ goods, such as florists, usually have a very high inventory turnover ratio.
Businesses that sell large volumes of low-priced or perishable goods, such as florists, usually have a very high inventory turnover ratio.
How is trade receivables turnover calculated?
Trade receivables turnover is calculated using this formula:
Trade receivables turnover = (trade receivables ÷ credit sales) × 365
It shows the average number of days taken to collect money from customers.
How is trade payables turnover calculated?
Trade payables turnover is calculated using this formula:
Trade payables turnover = (trade payables ÷ credit purchases) × 365
It shows the average number of days taken to pay suppliers' invoices.
True or False?
A business generally aims for a high or increasing trade payables turnover.
True.
It shows negotiation skills in arranging extended credit terms with suppliers, and delaying payments can improve cash flow.
How can a business improve its inventory turnover by holding less inventory?
It can reorder from suppliers more regularly, use just-in-time inventory management, dispose of obsolete inventory or reduce its product range.
How can incentives help reduce the trade receivables turnover?
Discounts or other incentives, such as free delivery, encourage customers to pay before the invoice's due date.
Carrying out ___________ on customers before offering trade credit helps keep the trade receivables turnover low.
Carrying out credit checks on customers before offering trade credit helps keep the trade receivables turnover low.
What are the risks of taking longer than agreed to pay suppliers?
Relationships with suppliers may worsen, leading to penalties, delayed orders or less trade credit. The business's creditworthiness may also fall, making borrowing harder.
Define gearing.
Gearing shows the balance between debt and equity finance in a business.
True or False?
A business with low gearing is higher risk but can usually grow faster.
False.
Low gearing is lower risk, but fast growth may be limited because the business takes a more cautious approach to borrowing.
Why does high gearing mean higher financial risk?
The business must make regular loan repayments and pay interest, even if profits fall.
Why do banks and investors use the gearing ratio?
They use it to judge whether the business can afford to take on more debt or is too risky to support.
How is the gearing ratio calculated?
The gearing ratio is calculated using this formula:
Gearing ratio = non-current liabilities ÷ capital employed × 100
The higher the gearing ratio, the more dependent a business is on _________________.
The higher the gearing ratio, the more dependent a business is on long-term borrowing.
A business has non-current liabilities of $9.6 million and capital employed of $43.3 million. What is its gearing ratio?
The gearing ratio is 22%, so the business is low-geared.
How do rising interest rates affect a highly geared business?
The cost of repaying loans rises, which may put strain on the business's finances.
True or False?
High gearing can damage a business's credit rating.
True.
A weaker credit rating may mean higher interest rates on future borrowing and make it harder to access additional funds.
How can a business lower its gearing by raising equity capital?
It can issue new shares to investors or keep profits in the business instead of paying them out as dividends.
A __________ offers existing shareholders the opportunity to buy additional shares.
A rights issue offers existing shareholders the opportunity to buy additional shares.
How can a business lower its gearing by reducing debt?
It can repay existing debt, starting with high-interest debt, or restructure its debt with creditors, for example by extending repayment periods.
When is high gearing less of a problem for a business?
High gearing is less of a problem when interest rates are low and expected to stay low, or when the business is large and profitable enough to meet its debt obligations.
Define financial return.
Financial return is the money made or lost on an investment over a period of time.
In what two forms do shareholders look for a return on their investment?
Shareholders look for an increased share price and increased dividends.
True or False?
Poor investment performance can lead to changes to the board of directors at the annual general meeting.
True.
Poor investment performance can cause shareholder discontent, and shareholders may vote for changes to the board.
How is dividend yield calculated?
Dividend yield is calculated using this formula:
Dividend yield = dividend per share ÷ market price per share × 100
True or False?
A rising share price increases a company's dividend yield.
False.
If the share price rises, the dividend yield falls. Investors may still be keen to invest, as a rising share price indicates positive company performance.
Why might a high dividend yield make an investment less attractive?
A high dividend yield can result from a fall in the share price caused by poor business performance.
How is dividend cover calculated?
Dividend cover is calculated using this formula:
Dividend cover = profit for the year ÷ annual dividend
The result shows the number of times profit covers the dividends paid.
A low dividend cover may lead shareholders to ____ their shares and switch to more stable investments.
A low dividend cover may lead shareholders to divest their shares and switch to more stable investments.
True or False?
A high dividend cover guarantees that a company will keep paying its current dividend.
False.
A high ratio does not guarantee a sustained dividend, because a company can choose to retain profits instead of paying a dividend.
What does the price/earnings ratio measure?
It measures the confidence investors have in a company's ability to generate future returns.
How is the price/earnings ratio calculated?
The price/earnings ratio is calculated using this formula:
Price/earnings ratio = market price per share ÷ earnings per share
Earnings per share is calculated as profit for the year divided by the number of ___________.
Earnings per share is calculated as profit for the year divided by the number of issued shares.
How do higher business profits improve investor return?
Higher profits allow greater dividends to be paid, and the share price is likely to rise, increasing the price/earnings ratio.
Why might a rise in dividend cover not be welcomed by short-term investors?
Dividend cover can rise because the company pays a lower dividend, using the profit to fund growth instead.
Define ratio analysis.
Ratio analysis involves comparing financial figures from the accounts to create meaningful measurements of profitability, liquidity and efficiency.
What might stable ratios over several years suggest about a business?
Stable ratios suggest a reliable and well-managed business, while sudden changes may point to risks or changing conditions.
How does comparing ratios with competitors help a business?
It benchmarks performance against the industry average, revealing strengths and weaknesses the business can work on.
True or False?
Financing growth with debt rather than equity lowers the gearing ratio.
False.
Taking on more debt increases the gearing ratio, showing greater financial risk. Using equity reduces gearing.
How can raising equity affect a business's ROCE?
Raising equity increases capital employed, which can reduce ROCE unless profits rise too.
Why can taking on more debt lower dividend cover?
More debt means higher interest payments, which reduce net profit and may make dividend payments less sustainable.
Dividend strategy is how a business decides how much profit to pay to shareholders and how much to ____ for future investment.
Dividend strategy is how a business decides how much profit to pay to shareholders and how much to retain for future investment.
How can paying high dividends affect the current ratio?
Paying high dividends reduces cash, a key current asset, so the current ratio may fall and liquidity weakens.
True or False?
Paying fewer dividends increases a business's capital employed.
True.
More profit stays in the business, so capital employed increases. This could lower ROCE unless operating profit rises from reinvestment.
How might business growth affect inventory turnover?
A growing business may build up more inventory or launch slower-selling products, so inventory turnover may fall.
How might business growth affect the price/earnings ratio?
If growth creates optimism, the share price may rise and increase the ratio. If growth creates uncertainty, such as high risk or debt, the ratio may fall.
_____________ happens when a business tries to make its accounts look better than they really are, for example by delaying bill payments.
Window dressing happens when a business tries to make its accounts look better than they really are, for example by delaying bill payments.
Why is the historical nature of published accounts a limitation?
Accounts are based on past performance, so ratios show what has happened, not what will happen next.
True or False?
Ratio analysis gives a full picture of a business because it includes factors such as staff morale and customer loyalty.
False.
Ratios and accounts ignore non-financial factors such as staff morale, customer loyalty and brand reputation, so they give only a partial picture.
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