Analysis of Accounts (Edexcel IGCSE Business): Flashcards
Exam code: 4BS1
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- FrontAccounting Ratios
Define ratio analysis.
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Cards in this collection (40)
Define ratio analysis.
Ratio analysis involves extracting information from financial accounts to assess business performance.
What is the formula for the gross profit margin?
Gross profit margin = (gross profit ÷ revenue) × 100.
What is the formula for the operating profit margin?
Operating profit margin = (operating profit ÷ revenue) × 100.
The gross profit margin shows the proportion of that is converted into gross profit.
The gross profit margin shows the proportion of revenue that is converted into gross profit.
True or False?
A higher gross profit margin means more revenue is being converted into profit.
True.
A higher and increasing gross profit margin is preferable, as more revenue is turned into profit.
Give two ways a business can improve its gross profit margin.
Increase sales revenue (e.g. raise prices) or reduce direct costs (e.g. find cheaper suppliers).
If gross profit is $105,731 and revenue is $124,653, what is the gross profit margin?
($105,731 ÷ $124,653) × 100 = 84.82%.
Define mark-up.
Mark-up is a measure of the profit made on each item sold, expressed as a percentage.
What is the formula for mark-up?
Mark-up = (profit per item ÷ cost per item) × 100.
A skateboard costs $12.13 to make and sells for $20. What is the mark-up?
Profit per item = $20 − $12.13 = $7.87; ($7.87 ÷ $12.13) × 100 = 64.88%.
Define return on capital employed (ROCE).
ROCE measures how effectively a business uses the capital invested in it to generate profit.
What is the formula for return on capital employed (ROCE)?
ROCE = (operating profit ÷ capital employed) × 100.
How is capital employed calculated?
Capital employed = non-current liabilities + equity.
True or False?
When analysing ROCE, a higher percentage is better.
True.
A higher ROCE shows the business is profitable and using its capital efficiently.
Give one way a business can increase its ROCE.
Increase profit without adding new capital, or maintain profit while reducing the capital in the business.
Define liquidity.
Liquidity is the ability of a business to pay back its short-term debts (for example, paying its suppliers).
Define insolvent.
A business that cannot pay its debts is insolvent.
Name the two liquidity ratios.
The current ratio and the acid test ratio.
What is the formula for the current ratio?
Current ratio = current assets ÷ current liabilities, expressed as ? : 1.
What is the formula for the acid test ratio?
Acid test ratio = (current assets − inventory) ÷ current liabilities, expressed as ? : 1.
Why does the acid test ratio deduct inventory?
Inventory is the least liquid current asset and often takes time to sell, so removing it gives a more realistic measure of meeting short-term debts quickly.
A business has current assets of $15,545 and current liabilities of $5,060. What is its current ratio?
$15,545 ÷ $5,060 = 3.07 : 1.
With current assets of $15,545, inventory of $8,250 and current liabilities of $5,060, what is the acid test ratio?
($15,545 − $8,250) ÷ $5,060 = $7,295 ÷ $5,060 = 1.44 : 1.
The acid test ratio is also known as the capital ratio.
The acid test ratio is also known as the liquid capital ratio.
True or False?
A current ratio of 3.07:1 means a business has $3.07 of current assets to cover each $1 of short-term debt.
True.
The current ratio shows how many units of current assets are available to cover each $1 of short-term debt.
Give one way a business can improve its liquidity.
Reduce the credit period offered to customers, sell off excess inventory, or use an overdraft (any one).
Why is a supplier interested in a business's liquidity?
To be reassured that the business is likely to be able to pay for the goods it orders.
If a business cannot pay its suppliers, raw materials may not be delivered and will be delayed.
If a business cannot pay its suppliers, raw materials may not be delivered and production will be delayed.
True or False?
Comparing liquidity ratios between different businesses is always straightforward.
False.
Some businesses survive on very low ratios (e.g. high inventory turnover and cash sales), so comparisons between different businesses are problematic.
Why do stakeholders use financial documents?
To assess business performance and inform decision-making.
How do managers use financial documents?
To track performance, identify areas for improvement, and make informed decisions to achieve objectives.
How do employees use financial documents?
To assess the stability of their employer — judging job security or supporting salary negotiations.
How do owners and shareholders use financial documents?
To assess profitability and growth potential, judging the ability to provide returns on their investment.
Why do suppliers look at a business's financial documents?
To assess its financial stability and check whether it can pay what it owes on time.
How do banks and other lenders use financial documents?
To judge whether a business is creditworthy and to assess the risk of lending before setting credit terms.
Owners and managers use the quantitative data in financial documents to make a range of informed .
Owners and managers use the quantitative data in financial documents to make a range of informed decisions.
Which financial document shows whether a business can afford new machinery, property or vehicles?
The statement of comprehensive income.
Name two types of decision managers make using financial documents.
Investment, financing, improving profit, or managing assets (any two).
True or False?
Only the owners of a business have an interest in its financial documents.
False.
Many stakeholders use them — managers, employees, suppliers, lenders and owners.
True or False?
The statement of financial position can show the impact of taking out a loan.
True.
It shows the impact of loans or other credit, plus the value of share capital and retained profit.
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