CAT / FIA FFM Syllabus F. Credit Management - Ratios and credit-worthiness - Notes 6 / 7
Ratio analysis
The credit controller is interested in a whole variety of accounting ratios, to build up a broad picture of the customer.
A problem with financial ratio analysis is that historical information about profits, assets and liabilities is used for an assessment of a future cash flow position.
The analysis and interpretation of the P&L and the SFP of a business can be done by calculating certain ratios, between one item and another, and then using the ratios for comparison.
Internally generated information and financial analysis
Ratio analysis can give some idea as to trends and highlight areas for further investigation
The current ratio is the ratio of current assets to liabilities.
The quick ratio measures liquidity more precisely.
The payables' payment period indicates the average length of time a company takes to pay its debts.
Together with receivables' turnover and inventory turnover this gives some idea as to the operations cycle.
Gearing ratios put payables in the context of the firm's overall borrowing: they are frequently unsecured.
Return on capital employed (ROCE)
Asset turnover
Profit margin
Changes in revenue
Strong revenue growth will usually indicate volume growth as well as turnover increases due to price rises, and volume growth is one sign of a prosperous company.