Assessing Financial Statements and Ratios Quiz

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Questions and Answers

What is the formula for calculating gearing as explained in the text?

Bank overdraft divided by capital employed (correct)

Loan capital plus bank/other borrowings divided by total capital employed

((Bank overdraft / Capital employed) x 100) / total capital employed

(Total capital employed / Bank overdraft) x 100

How is operational gearing defined in the text?

The profitability ratio of a company

The impact of fixed costs on profit generation

The percentage of total capital employed in a business

The relationship between fixed and variable costs in a business (correct)

What is the significance of assessing future profitability according to the text?

Evaluating the likelihood of continued profit generation and debt repayment capacity (correct)

Determining the company's current profit margin

Calculating the return on investment ratio

Ensuring that operational costs are minimized

In Example 2.1, what is the calculated gearing percentage for the company?

48.5% Signup and view all the answers

What does operational gearing help determine according to the text?

The likelihood of profitability and debt repayment capacity Signup and view all the answers

Based on the text, what is a key determinant of future profitability?

Ratio of fixed to variable costs Signup and view all the answers

What is the main reason why post-balance sheet deterioration in ratios based on normalised pricing would go unnoticed by external analysts?

The post-balance sheet deterioration is not immediately visible. Signup and view all the answers

Why is consistency in financial reporting over time considered a positive indicator?

It suggests reliable management and professional advisers. Signup and view all the answers

What is the primary purpose of tracking key accounting ratios alongside breakeven and cash flow analysis?

To provide a more balanced view of business performance patterns and trends. Signup and view all the answers

Why do businesses rely on terms of credit to purchase stock?

To facilitate the trading cycle through various steps. Signup and view all the answers

What do working capital ratios primarily indicate about a business?

Ability to manage day-to-day operations. Signup and view all the answers

How can accurate tracking of accounting ratios benefit lenders and investors?

By offering a more balanced view of performance patterns and trends. Signup and view all the answers

What is the purpose of working capital ratios in financial analysis?

To evaluate the liquidity and short-term financial health of a business Signup and view all the answers

In the context of financial analysis, what does an improvement in the current ratio from 1.75 to 2.00 signify?

An increase in the business's ability to meet short-term obligations Signup and view all the answers

Which ratio is used to assess how effectively a business is managing its assets to generate sales?

Asset turnover ratio Signup and view all the answers

What does the capital management ratio 'Earnings before interest, tax, depreciation and amortisation (EBITDA)' measure?

The profitability of a business after considering all expenses except taxes Signup and view all the answers

Which financial metric is crucial for assessing a business's ability to pay its short-term obligations when they come due?

Current ratio Signup and view all the answers

What is the significance of the funding gap mentioned in the text?

It indicates the period between cash outflows and inflows in a business cycle Signup and view all the answers

Study Notes

Gearing and Operational Gearing

Formula for calculating gearing: Not provided
Operational gearing: Defined as the relationship between a company's fixed and variable costs, which affects its profitability and breakeven point
Significance of assessing future profitability: Essential for determining a company's ability to generate earnings and remain competitive

Financial Ratios and Analysis

Calculated gearing percentage for the company in Example 2.1: Not provided
Operational gearing helps determine: A company's breakeven point and sensitivity to changes in sales and costs
Key determinant of future profitability: Ability to generate earnings
Post-balance sheet deterioration in ratios based on normalised pricing may go unnoticed by external analysts due to: Lack of access to up-to-date information

Financial Reporting and Consistency

Consistency in financial reporting over time: Considered a positive indicator because it allows for more accurate comparisons and trend analysis
Primary purpose of tracking key accounting ratios alongside breakeven and cash flow analysis: To gain a comprehensive understanding of a company's financial position and performance

Working Capital and Cash Flow

Businesses rely on terms of credit to purchase stock: To conserve cash and improve working capital management
Working capital ratios primarily indicate: A company's ability to manage its current assets and liabilities
Accurate tracking of accounting ratios benefits lenders and investors by: Providing a more accurate assessment of a company's creditworthiness and investment potential

Ratio Analysis

Purpose of working capital ratios in financial analysis: To assess a company's ability to manage its working capital and meet its short-term obligations
Improvement in the current ratio from 1.75 to 2.00 signifies: An improvement in a company's liquidity and ability to meet its short-term obligations
Ratio used to assess how effectively a business is managing its assets to generate sales: Asset turnover ratio
Earnings before interest, tax, depreciation and amortisation (EBITDA) measures: A company's ability to generate earnings from its core operations
Financial metric crucial for assessing a business's ability to pay its short-term obligations: Current ratio
Significance of the funding gap: Represents the amount of financing required to meet a company's working capital needs

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Description

Test your knowledge on assessing financial statements and ratios, with a focus on the concept of gearing in financial analysis. Measure your understanding of how gearing is used to evaluate a company's borrowing position.