Finance is often the most feared unit in Business Studies. But it's actually the most logical. Once you understand the story behind the numbers, you can analyze any business in minutes.
1. Liquidity Ratios
Can the business pay its short-term debts? That's all liquidity measures.
Current Ratio
Current Assets / Current LiabilitiesIdeal is 1.5:1 to 2:1. Too low means risk of insolvency. Too high means idle cash.
Acid Test Ratio
(Current Assets - Inventory) / LiabilitiesRemoves stock because stock can be hard to sell quickly. A safer measure of liquidity.
2. Profitability Ratios
Profit is good, but profitability is better. It measures how efficient you are at generating profit relative to sales or capital.
ROCE (Return on Capital Employed)
The king of ratios. It tells you the return investors are getting on their money.
Formula:
(Operating Profit / Capital Employed) × 100
Always compare ROCE with interest rates. If ROCE is 4% and the bank interest rate is 5%, you are better off putting your money in the bank!
3. Gearing Ratio
How risky is the business? Gearing measures the proportion of capital that is borrowed.
- High Gearing (Above 50%): Risky. High interest payments. Vulnerable to interest rate hikes.
- Low Gearing (Below 25%): Safe, but maybe too safe? The business might be missing opportunities for growth.
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