Content 6 Compute Financial Ratios (Ratios in RED NO longer in 2024 syllabus)

RATIO FORMULA Meaning Answer

LIQUIDITY RATIOS – shows ability to pay short term debts.
Current Ratio Current assets Test the ability of a business to Ans:1
Current Liabilities meet short term obligations ie pay
creditors.
Acid Test Current assets - stock Stricter test of liquidity. Ignores the Ans:1
Or Quick Ratio Current Liabilities least liquid of the current assets -
Stock
EFFICIENCY OR ACTIVITY RATIOS – measures how efficiently resources are utilised
Accounts Receivables Accounts Receivable x 365 Measures how long it takes a Days
or Collection Period Credit Sales business to obtain payment from its
Where the examiner asks for average customers.
accounts receivable you will need to
average it (see 2018).
Accounts Payable Accounts Payable x 365 Shows time period given by Days
Or Payment Period Credit Purchases or Cost of Sales suppliers for the firm to pay its
Where the examiner asks for average debts.
accounts payable you will need to
average it (see 2018).
Inventory Turnover Ratio Cost of Sales Measures the number of times in a Times
Average Stock year stock in a business is bought in
(Opening stock + closing stock) /2 and resold.
Asset Turnover Ratio Sales Measures how effective assets are Times
Total Assets – Current Liabilities being used to generate sales.
PROFITABILITY RATIOS – measures performance and operating success
Gross Margin Percentage Gross Profit x 100 Shows the % of sales that goes to %
Or Gross Profit Percentage Net Sales Gross profit.
Net Income Percentage Net Profit x 100 Measures net profit generated by %
Or Net Profit Margin Net Sales each dollar of sales.
Return on Assets Net Profit x 100 Measures profitability of assets %
Average Total Assets employed.
Return on Capital Employed Net Profit x 100 This ratio measures the profit made %
0r ROCE Capital Employed on the capital employed in it.
Where capital employed =
Total assets – Current liabilities
Price-Earnings Ratio Market Price per share Indicates investor’s assessments of Times
Or PE Earnings per Share the company’s future earnings
prospects.
Earnings per Share Net Profit Indicates the profitability of the $
Or EPS Number of ordinary shares issued firm and its ability to pay
dividends.
Dividend Payout Ordinary Cash Dividend x 100 Shows the amount of dividends %
Net Income paid to shareholders in relation to
the total amount of net income
generated
Dividend per share Total Ordinary Dividend Paid Shows the annual dividend of a $
Number of Ordinary shares in issue firm on a per share basis. Increases
gives investors confidence in
earning growth.
Dividend Cover Profit after Tax and Preference Shows the number of times Times
dividends ordinary dividend could be paid out
Ordinary dividends declared and paid of profits.
Dividend Yield Dividend per share Measures rate of return a %
Market Price per Share shareholder gets at the current share
price.
Return on Equity Net Profit x 100 Measures the amount of return an %
or Return on Capital Equity entity received from the owner’s
investment in it.
SOLVENCY RATIO – Measures the financial structure of the business.
Debt to Total Assets Ratio Total Liabilities x 100 Measures the % of total assets % 0r
Total Assets invested in the firm financed by Ans : 1
borrowing.
Debt To Equity Ratio Total Liabilities x 100 Shows the relationship between a % or
Or Gearing Equity company’s equity and debt capital. Times
Times Interest Earned Ratio Profit before Interest and Tax (PBIT) Measure’s ability or firm to meet Times
Or Interest Cover Interest Expense interest payments.
Long Term Debt to Equity Long term Liabilities x 100 Shows the relationship between a %
Equity company’s equity and long-term
debt.