11) Financial ratios Flashcards
what are the four categories of ratios
Profitability and return
Debt and gearing
Liquidity
Investor ratios
What do and are the profitability and return ratios tell you?
and name the categories they fall under
Profitability and return ratios are probably the most widely used. They are key to any financial manager wanting to assess performance against objectives as well as being crucial to the investment decision.
An external investor will also monitor these ratios closely when deciding whether to provide the company with finance and to assess the value of the overall business.
ROCE
Profit margins
Asset turnover
What is return on capital employed? ROCE
and main disadvantage
Return to all providers of capital
ROCE gives a measure of how efficiently a business is using the funds available. It measures how much is earned per $1 invested.
Operating profit
÷
Capital employed (Equity & Non Current liabilities)
Operating profit= Profit BEFORE interest and tax
CE= Total Assets - Current liabilities (leaves N/C Liabilities and Equity)
CE= Share capital + Reserves + Long term loans
Disadvantage: uses profit, which is not directly linked to the objective of maximizing shareholder wealth.
ROCE can be broken down into? %
Asset turnover
Net profit margin
What is asset turnover (Times) and the general formula
The asset turnover ratio can be used as an indicator of the efficiency with which a company is using its assets to generate revenue. The higher the asset turnover ratio, the more efficient a company is at generating revenue from its assets.
Sales Rev
÷
Capital employed (Equity and Non Current liabilities)
What are the two types of asset turnover
working capital
Non current asset turnover
what is working capital asset turnover formula
Working capital turnover is a ratio that measures how efficiently a company is using its working capital to support a given level of sales. shows the relationship between the funds used to finance a company’s operations and the revenues a company generates as a result
Sales rev
÷
Net working capital
what is non current asset turnover formula
Used to measure operating performance. This efficiency ratio compares net sales and measures a company’s ability to generate net sales from its fixed-asset investments (E.g. PP&E)
Sales rev
÷
N/C Assets
What is Net profit margin and formula %
what is the definition of net profit
The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit. i.e. how much % of the total revenue is actually profit
A comparison of the changes in the two ratios can often reveal more information about cost control and the changes in operating gearing. Operating profit can also be expressed as profit before interest and taxation (PBIT).
Net profit
÷
Sales rev
Net profit = Revenue - CoS - Operating expenses - Interest- Taxes
What are the two profit margin formula
A comparison of the changes in the two ratios can often reveal more information about cost control and the changes in operating gearing. Operating profit can also be expressed as profit before interest and taxation (PBIT).
Gross profit margin
Operating ratio
what is Gross profit margin
gross profit margin shows the amount of profit after cost of sales/goods sold
Gross profit
÷
Sales rev
what is Operating ratio
measures how much profit a company makes on a dollar of sales after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.
Expenses
÷
Sales rev
What is return on equity? ROE
ROE measures how much profit a company generates for its ordinary shareholders with the money they have invested in the company.
What is return on equity? ROE Formula
Profit after tax and preference dividend
÷
Equity
Equity= ordinary share capital + Reserves
what are the disadvantages of ROE
Disadvantages of ROE:
it uses profits, which are an unreliable measure and not directly linked to shareholder wealth
it is sensitive to gearing levels – ROE will increase as gearing ratio increases.
What are the debt and gearing ratios looking at?
Ratios that look at debt and gearing are a crucial way of assessing the risk profile of the business. They will therefore be used extensively by financial managers when taking financing decisions as well as by current and potential investors when assessing the amount of financing to offer and the level of return to demand.
what are the list of debt and gearing ratios?
Interest cover
Gearing
what is interest cover formula
Looks at the POV of P/L- How many times do we cover the interest that is payable in the P/L
Operating profit
÷
Interest payable
OP=Operating profits before debt interest and tax
What is the gearing ratio
Non current liabiliites
÷
Equity & Non current liabiliites
What is earnings per share
This is the basic measure of a company’s performance from an ordinary shareholder’s point of view. It is the amount of profit, in cents, attributable to each ordinary share.
Earnings available to ordinary shareholders
÷
No of ordinary shares in issue
Earnings available to OS= profit after interest and tax- Preference dividend
what are the disadvantages of EPS
EPS does not represent the income of the shareholder. Rather, it represents the investor’s share of profit after tax generated by the company according to an accounting formula.
When calculating the EPS, you cannot compare EPS of one company with EPS of another, as the answer would be meaningless. You should first calculate the growth rate of the EPS and then compare it with the growth of similar companies.
Although the ratio is simple in principle, in practice, there may be a number of complications as both the definitions of earnings and shares in issue require careful analysis. Accounting treatment may cause the ratios to be distorted, if for example the earnings figure includes the effects of extraordinary items.
What is PE ratio?
This is the basic measure of a company’s performance from the market’s point of view. Investors estimate a share’s value as the amount they are willing to pay for each unit of earnings. It expresses the current share price as a multiple of the most recent EPS/Current earnings.
If a PE ratio is high, investors expect profits to rise. This does not necessarily mean that all companies on high PE ratios are expected to perform to a high standard, merely that they are expected to do significantly better than in the past. They may have greater growth potential because they are coming from a low base.
what is PE formula
Share Price
÷
EPS
What is dividend per share (DPS)? %
The DPS helps individual (ordinary) shareholders see how much of the overall dividend pay-out they are entitled to in %
Since the shareholders are the owners of the business, they are entitled to their share of the profits. This is most simply achieved by paying the amount out as a dividend. It is usually expressed as an amount per share. This is because the total amount a shareholder gets has to reflect their share of the company.
What is dividend per share (DPS) formula %
Total ordinary dividend
÷
Total number of shares issued
what is dividend cover?
It is a measure of how many times the company’s earnings could pay the dividend. The higher the cover, the better the ability to maintain dividends if profits drop
what is dividend cover formula
and give the alternative formula
Profit available for ordinary shares
÷
Dividend for the year (interim plus)
OR
EPS
÷
DPS
What is dividend yield and formula
The dividend yield, expressed as a percentage, is a financial ratio that shows how much a company pays out in dividends each year relative to its stock price.
This provides a direct measure of the wealth received by the (ordinary) shareholder. It is the annual dividend per share expressed as an annual rate of return on the share price.
It means that if you buy a shares, the dividend ÷ by the amount you pay for the share is 5% return. You’re getting a 5% return in the form of a dividend when you buy that share
DPS
÷
Share price
what are the disadvantages of dividend yield?
it fails to take account of any anticipated capital growth so does not represent the total return to the investor.
What is TSR- Total shareholder return and an advantage?
This measures the returns to the investor by taking account of:
- Dividend income
- Capital growth
The TSR from an investment can easily be compared between companies or benchmarked against industry or market returns without having to worry about differences in size of the businesses.
what is TSR frmula?
DPS + Change in share price
÷
Share price at the start of period
What is interest yield and formula
The interest yield is the interest or coupon rate expressed as a percentage of the market price. It is a measure of return on investment for the debt holder.
Interest
÷
Market value of debt
WHAT is net assets?
Total assets - Total liabilities = Equity (Net Assets)
