9609 · 10.4.2
The use of accounting data and ratio analysis in strategic decision-making flashcards
Revision flashcards for Cambridge 9609 The use of accounting data and ratio analysis in strategic decision-making (syllabus 10.4.2). Flip, recall, then mark a real past-paper question.
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Ratio synthesis order?
Liquidity first (survival), then profitability, efficiency, gearing, investment — then overall judgement.
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Weak liquidity + high gearing?
Dangerous — may need equity injection, asset sale, or cost cutting urgently.
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Strong profitability + weak efficiency?
Earning well but tying up cash in inventory/receivables — improve working capital.
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Benchmarking?
Compare ratios with industry averages and prior years.
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Strategic response to falling ROCE?
Review product mix, cut costs, divest low-return assets, or reject new low-ROCE projects.
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Strategic response to high gearing?
Reduce debt, issue shares, improve profit to raise interest cover, delay expansion.
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Investment ratios for PLC strategy?
Low P/E may suggest takeover target; dividend policy affects shareholder support for strategy.
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Limitation of ratio-only analysis?
Window dressing, one-off items, different accounting policies — use with qualitative context.
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What is 'integrated ratio analysis' in a strategic context?
It is the use of a combination of different ratios (e.g., profitability, liquidity, gearing) to build a holistic view of the potential impact of a strategic decision, rather than relying on a single financial metric.
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How does the gearing ratio influence strategic choice?
It measures financial risk by showing the proportion of capital financed by debt. A high gearing ratio may restrict a firm's ability to borrow for expansion, acquisitions, or investment, thus limiting its strategic options.
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Why is ROCE a key ratio for strategic decision-making?
Return on Capital Employed (ROCE) measures how effectively a business is using its capital to generate profit. It is vital for comparing the potential profitability of different strategic options, such as investing in new machinery versus acquiring a competitor.
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Define 'due diligence' in the context of an acquisition.
A comprehensive appraisal of a business undertaken by a prospective buyer to establish its assets and liabilities and evaluate its commercial potential. It involves a deep analysis of financial ratios from the target company's accounts.
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What is a major non-financial limitation of using ratio analysis for strategy?
Ratio analysis ignores qualitative factors. It cannot measure brand loyalty, employee skills, corporate culture, or customer satisfaction, all of which are critical to the long-term success of any strategy.