Ratio analysis

• Capital employed = non-current liabilities + total equity
• return on capital employed = operating profit/Capital employed X 100

  -> positive ROI indicates a profitable investment, while a negative ROI suggests a loss
• Return on capital investment measures the profitability of a business

  -> Higher the ROCE the better
• Gearing ratio = Non-current liabilities / capital employed x 100

  -> Over 50% = highly good

  -> Under 50% = lowly geared
• Gearing ratio measures a company's debt to some form of its capital or equity

  -> higher gearing ratio indicates a higher level of financial leverage, meaning that the company has a larger proportion of debt relative to equity.
• working capital =  money that a business has to fund its day to day activities

  -> Current Assets - Current Liabilities
• managing working capital:

  • Effective management of working capital involves careful cash management
  • A business can have too much working capital
• In a highly-geared business more than 50 per cent of its capital employed are long-term loans

  • Substantial levels of interest will need to be paid on this high level of borrowing which means:
  • The level of profit available to pay as dividends to shareholders is reduced
  • Profit available to retain within the business is limited
• A low-geared business has less than 50 per cent of its capital employed as long-term loans

  • The outcome of the gearing ratio calculation will be less than 50 per cent
  • The business may be missing out on the opportunity to access finance without the need to dilute existing shareholders' control