Accounting Ratios Flashcards
Gross Profit
PERFORMANCE
Gross Profit/Revenue (*100%)
% of each ‘£’ of Revenue AFTER the COGS are Deducted
How efficiently the company uses LABOUR + SUPPLIES
Operating Profit margin
PERFORMANCE
Profit from Operations (EBIT)/Revenue (*100%)
% of each ‘£’ of Revenue AFTER Deduction: COGS + OPERATING Expenses
Money earned AFTER Deduction of OPERATING + INTEREST + TAX Expenses
ROCE
Return On Capital Employed
PERFORMANCE
HIGHER = Better
Profit from OPERATIONS (EBIT) /Capital Employed
- CE = Non-CA + (CA - CL) = E + Non-CL
- Working Capital = CA - CL
- CE = Total Equity + Total Debt (non-current L)
CE= total amount of capital used for the acquisition of profits.
How EFFICIENTLY + EFFECTIVELY a company has utilised its Capital during a period in generating Profit ( ~15% for Large companies).
HIGH = larger chunk of PROFITS can be invested BACK into the company for the Benefit of Shareholders—> Reinvested CAPITAL=> employed again at a HIGHER rate or Return = HIGHER EPS Growth = SUCCESSFUL GROWING Company.
(but if: low Reinvestment + unsustainable/lack of growth + High leverage of Debt + Focused short-term high return not Long-term growth)
LOW = NOT generating a High return on its Investment = Not efficient
ROCE is NOT Comparable between Companies in DIFFERENT Industries
Asset Turnover
(CE)
PERFORMANCE
HIGHER = Better
Revenue/Capital Employed
= number of times per annume
Sales Revenue generaged for every £1 of CE
How Effectively Companies are using their Assets to generate SALES
NON-Current Asset Turnover
PERFORMANCE
HIGHER = Better
Revenue/NON-Current Asset
Employee Efficiency Ratio
PERFORMANCE
LOWER = Preferred
Wage Costs / Revenue
- Wage Cost = TOTAL PAYROLL COSTS (not: wages/salaries)
the proportion of SALES paid out in Wage Costs
PERFORMANCE
Employee ratios
Return Per Employee Ratio
PERFORMANCE
HIGHER = Preferred
Operating Profit / Average No. of Employees
- O.P -> make sure to use the FULL Money Figure
Average Profit Generated PER Employee
Investment in PP&E Ratio for:
Are the OPERATIONS CAPITAL Intensive?
PERFORMANCE / Profitability - Efficiency
LOWER = Preferred
Net Book Value of PP&E / Revenue
- Shows how much investment in Fixed Assets for every ‘£’ of Revenue earned
if NBV is > Revenue = VERY CAPITAL INTENSIVE
may need to raise more MONEY by BORROWING
Investment in PP&E Ratio for:
How MUCH of the Assets has been USED UP?
(relative measure of Assets’ age)
LOWER = Preferred
FUTURE Capital Expenditure / Investment + Impact on C.F & Profitability
ACCUMULATED Depreciation Provision for PP&E / COST of PP&E
- H = Significant portion of the COST of the F.A has been Depreciated = OLDER = toward end of their Useful Life
–> Signal: upcoming REPLACEMENT / HIGHER Maintainance COSTS
OLDER = FREQUENT REPAIR + LESS EFFICIENT + TECH OUTDATED - L = NEWER = Less A. Depreciation
—> Imply: Lower Maintainance Costs + Less Immediate need for Replacement.
*different Depreciation methods
Investors and analysts: to gauge the need for FUTURE Capital Investments + potential impacts on C.F & Profitability.
Investment in PP&E Ratio for:
How ADEQUATE is a NEW Investment in PP&E?
- H / L ratios = what strategy?
HIGHER => GROWTH/expansion, or PROACTIVE maintenance + UPGRADES.
LOWER -> indicate UNDERINVESTMENT, which might lead to AGING Assets and potential FUTURE Operational INEFFICIENCIES
ADDITION to PP&E / (Depreciation Charge + IMPAIRMENT PP&E)
- How much the company is Investing in NEW F.A RELATIVE to the (De + Im) of existing F.A
H = Could mean the company is not only maintaining its asset base but also expanding it, adding capacity, or upgrading to newer technologies.
–> Sustained High Ratio: Indicates a focus on growth, which can be positive if DEMAND is INCREASING, but might also suggest OVERINVESTMENT if not aligned with Market Conditions.
L = May suggest the company is focusing MORE on maintaining its existing asset base rather than expanding it, which could be appropriate in a MATURE Market with STABLE DEMAND.
–> Sustained Low Ratio: May point to C.F CONSTRAINTS, strategic shifts to other types of investments, or a strategy to maximize SHORT-term profits by minimizing capital expenditures.
>1 implies ACTIVE Growth or MODERNIZATION Efforts
<1 may signal potential future ISSUES with AGING equipment (SUSTAINABILITY) and a NEED for INCREASED Capital Expenditures
EPS + P/E Ratio
*Key Performance Indicator = direct measure of HOW MUCH money a company is making for its SHAREHOLDERS –> return on investment for shareholders
PERFORMANCE + Profitability
HIGHER = MORE C.Shareholders can recieve
(Profit attributable to Equity Shareholders - PREFERENCE Dividends) / Avg. NO. of ORDINARY SHARES
- the MAXIMUM Ordinary Dividends a company could PAY to COMMON Shareholders
*Consistently INCREASING EPS suggests that the company is GROWING and becoming MORE PROFITABLE
*DECLINING EPS may signal Financial trouble or DECREASING PROFITABILITY
In Combination with P/E ratio = Over or Undervalued Stock
DIVIDEND Cover Ratio
*sustainability and reliability of the company’s dividend payments
Financial Position
HIGHER than 2 = HEALTHY
(Profit attributable to Equity Shareholders - PREFERENCE Dividends) / EQUITY or ORDINARY Dividends
EPS / DPS
- H= implies that the company RETAINS a significant portion of its Earnings AFTER paying DIV.
–> REINVESTMENT in the business + Paying down DEBT or other Corporate Purposes.
= PRUDENT+ SUSTAINABLE DIV policy
- L = using a LARGE portion of its Earnings to PAY DIV, which might NOT be Sustainable in the LONG-term, especially if Earnings fluctuate.
e.g: A ratio of 5 means that the company’s NI is 5 times the DIV Payment = indicating STRONG COVERAGE and a low risk of DIV Cut.
Inventory Turnover
FINANCIAL POSITION
HIGHER = Strong Sales
COST of Sales / Average Inventory
- Average Inventory = (Beginning I + Ending I) / 2
How many times Inventory is turned over in a year
FINANCIAL POSITION
Inventory Days
FINANCIAL POSITION
LOWER = Better
Average Inventory / Cost of Sales (*365 days)
How long Inventory’s been stored BEFORE sold
FINANCIAL POSITION
Days Receivables
FINANCIAL POSITION
in line with CREDIT Terms
Trade Receivables / **Credit SALES ** (*365)
HIGH = Increases unnecessary financing costs + Not enough cash
Time to COLLECT
Days Payables
FINANCIAL POSITION
in line with CREDIT Terms
Trade Payables / Credit PURCHASES or COST of Sales (*365)
HIGH = extra cash available + advantageous
Time to PAY
Operating Cycle
Working Capital Management
H = BAD
Inventory Days + Receivables Days - Payables Days
- H = MORE PRESSURE on Liquidity (H=G, C.Ratio <- More Inventory held, & L=B, Q.Ratio <- Liquidity relied on Inventory NOT Cash) + ROCE (Worse TURNOVER Ratio = Lower O.P)
Efficiency of Managing Short-term Trading Assets
Current Ratio
FINANCIAL POSITION
Liquidity
CA/CL
(>1.5)
HIGHER = MORE Assets than Liabilities
Extent of CL are COVERED by CA (tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables)
Acid Test (Quick Ratio)
FINANCIAL POSITION
Liquidity
(CA - Inventory) / CL
(>1)
Without relying on the Sale of Inventory
cover with MOST LIQUID CA (Cash / Receivables)
Cash Ratio
Liquidity
(Cash + Cash Equivilant + Marketable Securities) / CL
(>1)
Cover with ONLY Cash + Cash Equivilant
1 main ratio and 2 additional
Gearing / Leverage
D.Holders: more D. Obl. to MEET + LOWER Interest Coverage Ratio = Defaulting on loan repayments, + risk of BANKRUPTCY, + L. CREDIT RATING
O.Shareholders: FAVOURED F.Leverage, + Enhanced AFTER-TAX Profits from TAX SHIELD, + Increased FUTURE Earings from Asset Growth by DEBT Financing
Financial Position / Risk
L-Liabilities (Debt) / C.E (E + L-Liabilities) *100%
D:E ratio and D:A ratio
- Ratio of Financing through DEBT and Financing through Equity or C.E
- H = BAD for D.Holders (more D. Obl. to MEET = Interest payments INCREASED – esp. if profits are falling + LOWER Interest Coverage Ratio = inability to meet Interest Obl = risk of Defaulting on loan repayments) + risk of BANKRUPTCY –> esp. A INSUFFICIENT to cover all L during Liquidation. + L. CREDIT RATING (H-Borrowing Cost + Reduces access to New Credit) = More risk for Existing D.Holders.
–> MORE Profits are needed to cover Interest Obl.
= Potential BENEFITS for Ordinary Shareholders (HIGHER Return <- Earnings from return on its Investments > Int. rate on Debt) = FAVOURED F.Leverage (<- D used to ^ Potential return on E) + Enhanced AFTER-TAX Profits from TAX SHIELD (<- Int. Payments on D = TAX-DEDUCTIBLE => reduce taxable income => ^ N.I available to Shareholders = H. Div + Share .P) + Increased FUTURE Earings from Asset Growth by DEBT Financing (<- provide necessary capital for expansion WITHOUT DILUTING OWNERSHIP)
Earnings volatility, Cut Div. Payments, Threatened L-Financial Stability
Interest Cover Ratio
LOWER = ^ RISK of DEFAULT
Gearing + ICR = ability to Continue TRADING & Raise NEW LOANS
Operating Profit / Finance Expense
- EBIT / Interest Expense
LOWER = HIGHER risk of DEFAULT ( NOT enough O.P to cover F.E or Interest Cost)
