Ratios: questions, not verdicts
Introduit| English | Sens |
|---|---|
| current ratio/ˈkʌrənt ˈreɪʃɪəʊ/ | Current assets divided by current liabilities, used as an indicator of short-term liquidity. |
| gearing/ˈɡɪərɪŋ/ | Debt as a share of capital employed. |
| gross margin | Gross profit as a share of revenue. |
| return on equity | Profit as a return on the funders' stake. |
| receivable days | receivable days |
A current ratio of 11.5: excellent?
- A textbook says a current ratio above 2 is "good". At the end of year 1, Nimbus's current ratio is 11.5.
- Is Nimbus's money well managed, or is something odd? This lesson treats each ratio as a question to ask, not a mark to award.
A ratio is one number over another
- A ratio divides one statement figure by another, so firms of different sizes can be compared. Each family asks one question.
- Margins: is the pricing right? Liquidity: can the bills be paid soon? Gearing: how much is funded by loans? Return: what do the owners earn on their money?
The core set
- Gross margin 毛利率 $= \dfrac{\text{gross profit}}{\text{revenue}}$; operating margin $= \dfrac{\text{profit}}{\text{revenue}}$. Current ratio 流动比率 $= \dfrac{\text{current assets}}{\text{current liabilities}}$.
- Gearing 资本负债率 $= \dfrac{\text{debt}}{\text{debt} + \text{equity}}$. Return on equity 净资产收益率 (ROE) $= \dfrac{\text{profit}}{\text{equity}}$.
Which ratio answers it?
Each question comes from Nimbus's owner. Sort it to the ratio that answers it; each ratio is built to answer one kind of question.
Match each ratio to its formula.
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Each ratio puts the figure that answers the question over the figure that sets its size.
Cash £51,400, inventory £3,600 and prepaid rent £9,000 are current assets; current liabilities are £5,550. What is the current ratio? Give one decimal place.
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$\dfrac{51\,400 + 3\,600 + 9\,000}{5\,550} = \dfrac{64\,000}{5\,550} \approx 11.5$.
Nimbus's year 1, computed
- Gross margin: $\dfrac{93\,600}{156\,000} = 60.0\%$. Operating margin: $\dfrac{28\,370}{156\,000} = 18.2\%$.
- Current ratio: current assets $51\,400 + 3\,600 + 9\,000 = 64\,000$ against current liabilities $4\,000 + 400 + 250 + 900 = 5\,550$, so $\dfrac{64\,000}{5\,550} = 11.5$.
- Gearing: $\dfrac{15\,000}{15\,000 + 48\,370} = 23.7\%$.
Year 2 revenue is £182,000 and profit is £30,100. What is the operating margin, as a percentage to one decimal place?
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$\dfrac{30\,100}{182\,000} \approx 0.165$, so 16.5%, down from 18.2% in year 1 as cheaper café sales grow.
Why 11.5 is a warning, not a prize
- Most of the £64,000 is cash, and most of that cash was raised from shares and the loan, not earned. It sits in the bank earning almost nothing.
- The ratio is correct; the reading "above 2 is good" is what fails. A very high current ratio asks: why is this money not being used?
What does Nimbus's year-1 current ratio of 11.5 most likely signal?
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£64,000 of current assets against £5,550 of bills. Most of the cash came from shares and the loan and is not yet working.
Year 2 changes the story
- Nimbus starts selling to cafés at wholesale prices: gross margin falls to 57.0%. Cafés pay on 24-day terms, and receivable days 应收账款周转天数 $= \dfrac{12\,000}{182\,000} \times 365 = 24.1$: almost exactly on the term.
- After a £20,000 dividend and £5,000 of loan repaid, equity is £58,470 and the loan £10,000, so gearing falls to $\dfrac{10\,000}{68\,470} = 14.6\%$.
Receivable days are 24.1 and cafés are given 24 days to pay. What does this show?
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$\dfrac{12\,000}{182\,000} \times 365 \approx 24.1$ days, almost exactly the agreed term.
In year 3 Nimbus repays another £4,000 of its £10,000 loan, and equity grows to £65,000. What is gearing, as a percentage to one decimal place?
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Debt is $10\,000 - 4\,000 = 6\,000$, so gearing is $\dfrac{6\,000}{6\,000 + 65\,000} = \dfrac{6\,000}{71\,000} \approx 8.5\%$.
Time, peers and definitions
- Time: one year's level says little; the trend says more. Year 1's ROE of $\dfrac{28\,370}{48\,370} = 58.7\%$ reflects the founders' small £20,000 stake more than an outstanding bakery.
- Peers: a 60% gross margin means one thing for a bakery and another for a software firm. Compare with similar businesses.
- Definitions: check which profit, which equity and which debt before comparing two numbers.
How should you read Nimbus's year-1 ROE of 58.7%?
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A small capital base makes any profit look like a huge return. Compare the trend over several years and with similar bakeries before judging.
A 60% gross margin is high for any kind of business.
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Margins depend on the sector. A bakery and a software company have very different costs, so compare with peers.
Recap
- Margins ask about pricing, liquidity about cover, gearing about funding, return about the owners.
- A ratio is a question; time, peers and definitions decide the answer.
- An extreme value, high or low, is a reason to look closer.