POFM - introducing ratios - the current ratio and debt to equity ratio Flashcards Preview

12-BS-Finance > POFM - introducing ratios - the current ratio and debt to equity ratio > Flashcards

Flashcards in POFM - introducing ratios - the current ratio and debt to equity ratio Deck (13)
Loading flashcards...
1
Q

what is the purpose of financial ratio

A

highlights relationships between variables and allow the business financial position to be assessed.

2
Q

types of financial ratio

A

Liquidity – ability to pay debts in the short term
Profitability – how much money the business is making
Solvency – ability to pay debts in the longer term Efficiency – how well the business is using its resources

3
Q

Liquidity

A

business ability’s to pay its debts in the short term
Ie measures the resources available to pay debts when they fall due

Liquidity is measured in the current ratio

4
Q

current ratio =

A

Current Assets/Current liabilities

it is written as a ratio of x: 1 and means the business has $x of current assets for every $1 of current liabilities.

5
Q

what does a current ratio mean???

A

allows financial managers to gauge whether the business is in a position to pay off its current liabilities using its current assets alone

6
Q

Large ratio

A

(1.5:1 or higher) the more liquid a business is and can easily meet its short term financial obligations

7
Q

smaller ratio

A

(less than 1.5:1) the less liquid a business is and that harder it is for the business to meet these short term obligations.

8
Q

(2.5:1 and higher)

A

a business can be too liquid, cash can be sitting on the balance not working for the business.

9
Q

solvency or gearing

A

Solvency is a measure of long term financial stability and refers to a business’s ability to pay their debts in the longer term

Gearing measures that mix of debt and equity as forms of funding within a business

10
Q

Solvency is measured by the debt to equity ratio

debt to equity ratio=

A

debt(total liabilities)/Equity(OE)

It is always written as a ratio i.e. x:1 and means the business has $x of debt for every dollar of equity

11
Q

but what does this mean?

A

the mix of debt and equity used by the business and is a measure of long term financial risk depending on the level of debt used

12
Q

The greater the ratio (DTER)

A

the more debt that is used for finance and the higher the potential risk.

13
Q

The lower the ratio (DTER)

A

the more equity that is being used and the lower the potential risk