What is depreciation?
The fall in the value of a non-current asset
Where is depreciation recorded?
in the profit and loss account as a business expense
on the balance sheet to reflect the fall in the market value of the asset
What is the first method to measure depreciation?
The straight line method
spreads the depreciation evenly over the useful life of the non-current asset being depreciated. Hence, the value of the asset falls by equal amounts each year
What is the formula for annual depreciation (straight line)?
purchase price - residual value / estimated useful life
What is the second method to measure depreciation?
Units of production method
calculating the loss in value of an asset by estimating the units produced anually
What is the formula for annual depreciation (units of production)?
yearly units of production / total estimated lifetime production x (original asset value - residual asset value)
How does ratio analysis help businesses?
it helps them to:
understand the relative size of their profits
identify trends in profitability, liquidity and efficiency over time
control their costs
make decisions about investments and growth
make comparisons with competitors in the same industry
What does the gross profit margin do?
It compares the gross profit to the sales revenue
What is the profit margin?
It shows the profit before income and tax as a percentage of sales revenue
What is the ROCE?
It measures the business’s profit before interest and tax in terms of the capital that has been ‘employed’ or used in the business
What are the current ratio and the acid test used for by banks?
Banks use them to determine whether they should make loans to companies
Why might a too high current ratio be inefficient?
It shows that there is too much money held in cash that could be invested more effectively in the business
How can a business improve the current ratio?
It needs to increase its current assets and/or reduce its current liabilities
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