ASSIGNMENT

Assignment

Assignment

Question 1

Part a) Cembelene plc Ratios

Ratios

 

 

 

Liquidity Ratios

 

 

 

Current Ratio

1.56

Quick Ratio

0.94

 

 

Profitability Ratios

 

 

 

Gross Profit Margin

54%

Return on Assets

23%

Return on Equity

28%

There are 3 main categories of ratio:

Profitability Ratios - these include the Return on Total Assets, Return on Capital Employed, Net Profit Margin and Net Asset Turnover and are used to assess how profitable the company is.

Short-term liquidity ratios - these include the current ratio and the acid test ratio and measure how easily the company can meet its short-term financial commitments like paying its bills.

Long-term liquidity ratios - these include the Gearing and Interest Cover ratios and measure the extent to which the capital employed in the business has been financed either by shareholders or by borrowing and long term finance.

To fully analyze a set of accounts, you will need a reasonable knowledge of each or these types of ratio, so try to work gradually through the explanations and worksheets to build up your understanding.

 

Profitability Ratios

The absolute level of profit may provide an indication of the size of the business, but on it's own it says very little about company performance. In order to evaluate the level of profit, profit must be compared and related to other aspects of the business. Profit must be compared with the amount of capital invested in the business, and to sales revenue.

Profitability ratios will inevitably reflect the business environment of the time. So, the business, political and economic climate must also be considered when looking at the trend of profitability for one company over time. Comparisons with other businesses in the same industry segment will provide an indication of management's relative ability to perform in the same business and economic environment.

The key profitability ratios are:

 

Return on Total Assets (ROTA)

=

 Net profit before interest and taxes Fixed assets plus current assets

x 100

Return on capital employed (ROCE)

=

 Net profit before interest and taxes Total Capital Employed

x 100

Net profit margin

=

 Net profit before interest and taxes Sales revenue

x 100

Net asset turnover

=

   Sales revenue   Capital employed

 

 

SHORT TERM LIQUIDITY

Short-term liquidity is the ability of the company to meet its short-term financial commitments. Short-term liquidity ratios measure the relationship between current liabilities and current assets. Short-term financial commitments are current liabilities, which are typically trade creditors, bank overdrafts PAYE, VAT and any other amounts that must be paid within the next twelve months. Current assets are stocks and work-in-progress, debtors and cash that would normally be re-circulated to pay current liabilities.

The key short-term liquidity ratios are:

 

Current Ratio

=

  Current assets  Current liabilities

Acid Test Ratio

=

Current assets - stockCurrent liabilities

 

Current Ratio

The current ratio is a general indicator of the business's ability to meet its short-term financial commitments. This ratio assumes that all current assets, if required, can be converted to cash immediately in order to meet all current liabilities immediately. Many texts recommend that the current ratio should be at least 2:1, that is current assets should be at least twice the value of current liabilities. Presumably, this is to allow a safety margin, as current assets do not usually achieve their full value if they have to be converted to cash in a hurry.

Nowadays, it is very difficult to prescribe a desirable current ratio. Technological advances in stock and inventory management have reduced ...