Please enable JavaScript.
Coggle requires JavaScript to display documents.
Ratio Analysis - Coggle Diagram
Ratio Analysis
Liquidity Ratios
-
-
Both are calculated in order to understand the balance between the company's short-term debt and the assets it can use to meet that debt ( cash or converted assets )
-
-
meaning a business would have £1.50 of current assets for every £1 of short-term debt. This is deemed comfortable and enough to be able to cover debts without holding too many resources in unproductive forms
-
-
-
-
GEARING
measures the long term financial healht of a business - the gearing ratio expresses long-term liabilities as a percentage of the totoal amount of long term capital in the business.
-
for example if a business is financed by 50m of loans and 50m of equity, the gearing ratio would be 50%
Capital employed adds the share capital to the loan capital to work out the total long-term finance in the business.
50% is regarded as the danger level over which is normally unadvised to pass, this is because the problem with a high gearing is the amount of cash it drains. with interest payments to make, as well as loan repayments, high levels of debt can suck the cash from a business rapidly.
To reduce an unhealthy high gearing ratio, several options are open: issue more shares, retain more profits and repay some loans.
Profitability Ratios
-
-
This expresses operating profit as a percentage of the capital that has been invested in the business. Therefore it shows a return on that capital that is comparable with other potential users of capital, such as leaving the money in the bank to earn interest.
Higher figures are better for this ratio, since a higher return means the money invested in the business is generating a higher return on that investment
-
Types of Ratio
-
each tells us about a different aspect of the company's performance and financial health, taken together they can really unveil the financial statement
-
Interpretation
Ratios can help make key business decisions, gearing and liquidity ratios help to identify whether a business can afford to invest money in new projects. Meanwhile, return on capital employed can help to assess the attractiveness of a new investment or identify underperforming parts of the business.
The major issue is the lack of detail provided within the financial accounts and they paint a misleading healthy picture.
On the profit and loss accounts, net profit can be affected by one-off transactions which fail and this will simply be a blip, perhaps misleading to those who do not investigate further than a ratio result.
-