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Ratio analysis
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- 1How can we use ROCE analysis? - component 1 and 21. The change in ROCE from one year to the next can be examined.
2. The ROCE being earned by other companies can be compared with
the ROCE of this company.
3. A comparison of the ROCE with current market borrowing rates may be made - 2How ROCE can be judged in terms of current market borrowing rates? - 1st pointWhat would be the cost of extra borrowing to the company if it needed more loans, and is it
earning a ROCE that suggests it could make profits to make such borrowing worthwhile? - 3How ROCE can be judged in terms of current market borrowing rates? - 2nd pointIs the company making a ROCE which suggests that it is getting value for money from its current borrowing?
- 4Formula of ROE (return on equity)Profit after tax and preference shares/equity shareholder funds
- 5Express ROCE with asset turnover and profit marginsProfit margin * asset turnover = ROCE
- 6Formula of asset turnoverRevenue/capital employed
- 7How revenue should be analysed?Comments should look to explain why revenue
has increased in the year, examining items such as new products, new markets,
promotional activity or anything relevant to the scenario. - 8What are questions to asl in gross profit analysis?Are there any reasons why the selling price has changed?
• Are there any significant changes to the costs in the year?
• Has there been any indication of a change in sales mix? - 9If gross profit has not increased in line with sales revenue where we should look?increased ‘purchase’ costs: if so, are the costs under the company’s
control (i.e. does the company manufacture the goods sold)?
• inventory write-offs (likely where the company operates in a volatile
market-place, such as fashion retail)? or
• other costs being allocated to cost of sales – for example, research
and development (R&D) expenditure? - 10What questions should we ask in operating profit margin analysis -1&2?Are the changes in line with changes in gross profit margin?
• Are the changes in line with changes in sales revenue? - 11What questions should we ask in operating profit margin analysis -3&4?As many costs are fixed they need not necessarily increase/decrease
proportionately with a change in revenue.
• Look at individual categories (administration, distribution expenses) - 12What needs to be considered if there are significant changes within operating expenses? - 1Are these due to one-off items, such as redundancies or litigation? If so,
these items should be stripped out of the ratio to provide a meaningful
comparison. - 13What needs to be considered if there are significant changes within operating expenses? - 2Are there likely to be ongoing future consequences? For example, a
company opening a website to sell directly to the public is likely to have
much higher distribution costs into the future. - 14Does ROCE take into account lease liabilities?Yes, both current and non-current
- 15How ROCE is compared?the previous year ROCE
• the cost of borrowing
• other entities’ ROCE in the same industry. - 16How movement in ROCE should be analysed?by looking for the reasons why profit
has moved, and reasons for any changes in the long-term funding, such as
loans or share issues to fund acquisition of non-current assets. - 17How revaluation affects ROCE?A company that revalues their non-current assets will have
a revaluation surplus in equity. This will make their ROCE lower than a
company that does not revalue their assets, making comparison meaningless. - 18How cost of borrowing can be compared to ROCE?if the cost of borrowing is, say, 10% and
ROCE 7%, then further borrowings will reduce EPS - 19Explain tradeoff between margin and asset turnoverLow-margin businesses (e.g. food retailers) usually have a high asset
turnover.
• Capital-intensive manufacturing industries (e.g. electrical equipment
manufacturers) usually have relatively low asset turnover but higher
margins. - 20How high current ratio can be looked suspiciously?as it may be due to:
• high levels of inventory and receivables (check working capital
management ratios)
• high cash levels which could be put to better use (e.g. by investing in noncurrent assets). - 21What an increase in inventory days indicate?inventory
is turning over less quickly which is regarded as a bad sign as it may indicate:
• lack of demand for the goods
• poor inventory control
• an increase in costs (storage, obsolescence, insurance, damage). - 22What else should we look when inventory days increase?buying inventory in larger quantities to take advantage of trade discounts,
or
• increasing inventory levels to avoid stockouts. - 23Apart from bad sign, what increasing receivable days could indicate?a deliberate policy to attract more trade, or
• a major new customer being allowed different terms - 24How the receivable days can be distorted?using year-end figures which do not represent average receivables
• factoring of accounts receivables which results in very low trade receivables
• sales on unusually long credit terms to some customers - 25What can long period of trade payables indicate?the company may develop a poor reputation as a slow payer and may not
be able to find new suppliers
• existing suppliers may decide to discontinue supplies
• the company may be losing out on worthwhile prompt payment discounts - 26Where preference shares belong to?To debt
- 27Which entities are suitable for high gearing?those
in property investment and the hotel/leisure services industry. These
entities generally enjoy relatively stable profits and have assets which are
highly suitable for charging - 28Which entities are not suitable for high gearing?An entity with most of its
capital invested in fast-depreciating assets or inventory subject to rapid
changes in demand and price would not be suitable for high gearing. - 29What does low interest cover indicate?low interest cover indicates to shareholders that their dividends are at risk (because most profits are eaten up by interest payments) and
• the company may have difficulty financing its debts if its profits fall - 30After which point interest covers are considered unsatisfactory?interest cover of less than two is usually considered unsatisfactory
- 31What does lower level of dividend yield indicate?the more the market is expecting future
growth in the dividend, and vice versa. - 32What is formla for dividend cover?PBIT or profir after tax / dividend
- 33What does dividend cover indicate?The higher the dividend cover, the more likely it is that the current dividend
level can be sustained in the future. - 34What are limitations of ratio analysis?They ignore future action by management.
• They can be manipulated by window dressing or creative accounting.
• They may be distorted by differences in accounting policies. - 35Provide example of window dressing?a company might chase receivables more quickly at the year end to
improve their bank balance; - 36Provide example of window dressing- 2a company may change its depreciation estimate i.e. by increasing
the expected useful economic life of an asset, the depreciation
charge will be smaller resulting in increased profits; and - 37Provide example of window dressing- 3an existing loan may be repaid immediately before the year end and
then taken out again in the next financial year. - 38How transaction with related parties affect ratios?If an entity trades with related parties, such as other entities within the same
group or other entities run by the same directors, then these transactions may
not be at market price. - 39—
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- ACCA FR (F7) Karteikarten am Ratio analysis, erstellt von Archimed Nemes am 22/04/2019.
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