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?

<p>48.5% (A)</p> Signup and view all the answers

What does operational gearing help determine according to the text?

<p>The likelihood of profitability and debt repayment capacity (D)</p> Signup and view all the answers

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

<p>Ratio of fixed to variable costs (D)</p> 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?

<p>The post-balance sheet deterioration is not immediately visible. (D)</p> Signup and view all the answers

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

<p>It suggests reliable management and professional advisers. (C)</p> Signup and view all the answers

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

<p>To provide a more balanced view of business performance patterns and trends. (C)</p> Signup and view all the answers

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

<p>To facilitate the trading cycle through various steps. (B)</p> Signup and view all the answers

What do working capital ratios primarily indicate about a business?

<p>Ability to manage day-to-day operations. (D)</p> Signup and view all the answers

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

<p>By offering a more balanced view of performance patterns and trends. (D)</p> Signup and view all the answers

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

<p>To evaluate the liquidity and short-term financial health of a business (B)</p> 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?

<p>An increase in the business's ability to meet short-term obligations (B)</p> Signup and view all the answers

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

<p>Asset turnover ratio (C)</p> Signup and view all the answers

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

<p>The profitability of a business after considering all expenses except taxes (A)</p> 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?

<p>Current ratio (D)</p> Signup and view all the answers

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

<p>It indicates the period between cash outflows and inflows in a business cycle (A)</p> Signup and view all the answers

Flashcards

Operational Gearing

The relationship between a company's fixed and variable costs, influencing profitability and the breakeven point.

Future Profitability Assessment

The ability of a company to generate earnings and remain competitive.

Gearing Ratio

Calculates how much a company has borrowed relative to its equity.

Operational Gearing Analysis

Assessing the relationship between fixed and variable costs, essential for determining a company's breakeven point and sensitivity to changes in sales and costs.

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Breakeven Point

The minimum amount of sales required to cover all fixed costs.

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EBITDA

The ability to generate earnings from core operations.

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Financial Reporting Consistency

Ensuring consistency in financial reporting over time to enable more accurate comparisons and trend analysis.

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Financial Position and Performance Evaluation

Provides a comprehensive financial picture by tracking key accounting ratios, breakeven analysis, and cash flow analysis.

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Working Capital Ratio Analysis

Assessing a company's ability to manage its working capital in meeting short-term obligations.

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Current Ratio

A ratio that measures a company's ability to meet its short-term obligations with its current assets.

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Asset Turnover Ratio

A ratio that measures how effectively a company uses its assets to generate sales.

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EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization)

A company's ability to generate earnings from its core operations, excluding related costs.

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Funding Gap

The difference between a company's projected financing needs and its available funds.

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Businesses Rely on Terms of Credit

To conserve cash and improve working capital management.

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Working Capital Ratios

Indicates a company's ability to manage its current assets and liabilities.

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Accurate Tracking of Accounting Ratios

Provides lenders and investors with a more accurate assessment of a company's creditworthiness and investment potential.

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Current Ratio Improvement

An improvement in a company's liquidity and ability to meet its short-term obligations.

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Funding Gap Significance

Represents the amount of financing required to meet a company's working capital needs.

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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.

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