Financial accounting ratios Flashcards
Name all 5 relevant profitability ratios
- Return on capital employed.
- Asset turnover
- net profit margin.
- Gross profit margin
- Expenses as a % of sales
Return on capital employed (ROCE) formula and meaning
PBIT / Equity + Long debt (Capital employed)
Effective measurement of how well a company is using all thats made available to it to create a profit.
A higher ROCE suggests a more efficient company.
Asset Turnover formula and meaning
Revenue / capital employed
A higher number shows the company can effectively use its assets to generate revenue.
Low suggests internal problems.
Net profit margin
Net profit / revenue
The amount of revenue which is true profit. Creates a profit margin. Highly affected by overhheads.
Gross profit margin
Gross profit / revenue
The profit earned from the trading activities of the business.
Expenses as a percentage of sales
Epense item / revenue
As the business grows, economies of scale should make this ratio decrease.
It shows if a business is using its revenue effectively.
What are the two main liquidity ratios and discuss liquidity as a concept.
Current ratio
Liquid ratio
The ability of a business to meet its short-term liabilities as they fall due.
Businesses need cash to do so, but also consider highly liquid assets in calculations.
Net current assets = Current assets - current liabilities.
Current ratio
Current assets / current liabilities
Measures the balance of current assets and liabilities, expressed as a ratio. You don’t want too much cash tied up in receivables (CA) or too many receivables (CL)
Liquid ratio / Acid test / quick ratio.
Current assets - inventories / Current liabilities
The same as the current ratio but excludes inventories as to not skew result.
What are the main four efficiency ratios?
- Asset turnover
- Inventory turnover
- Receivables collection period.
- Payable payment period.
Efficiency ratios put a time - frame on how quickly a business can convert its assets into cash.
Inventory turnover
Inventories / cost of sales x 365
Inventories as an average of opening and closing, or closing if no opening figure is given.
Receivables collection period
Trade receivables / credit sales x 365
Measure of how long credit customers take to pay their bill.
Credit sales might not be available, so total sales is used.
An average of opening and closing receivables is a good denominator.
Payable payment period
Trade payable / credit purchases x 365
If credit purchases not available, we use COS.
Provides a useful indicator of credit period taken from the supplier.
The working capital cycle
Estimates the time taken to convert cash back into cash through the operating cycle.
Inventory turnover + Receivables collection period - payables payment period.
What are the three main gearing ratios?
- gearing
- Financial leverage.
- Interest cover
Capital gearing
Total borrowings / capital employed.
The proportion of capital financed by debt, rather than equity funds.
Higher suggests more risk, and lower EPS as payments for interest required.
Debt / equity ratio
Total borrowings / shareholders funds x 100
The higher the percentage, the higher the risk.
Interest cover
PBIT / Finance cost
Expressed as number of times.
Higher, less risky. As a companies gearing increases, the interest cover will decrease as interest payments (finance costs) increase
What are the 7 main investor / stock market ratios?
- Return on equity (ROE)
- Earnings per share (EPS)
- Price earnings ratio
- dividend per share
- dividend cover
- dividend yield.
- Total shareholder returns.
Return on equity
Profit to shareholders / shareholders funds (equity)
Assesses the total returns going back to shareholders. expressed as a percentage.
Earnings per share
Profit after tax and dividends / number of ordinary shares in issue.
Key ratio for equity investors.
Could be basic EPC (Shares in issue) OR
Diluted EPS (Shares being considered).
A high number reflects a better performance.
Based on historical information, doesn’t look at inflation.
Earnings per share info
EPS Is the only ratio required to be shown on the face of a publicly traded companies’ income statement.
Some unusual items are excluded from the statistic. Disposals, write offs, etc.
EBITDA is often an alternative EPS figure.
Price / earnings ratio
Market price per share / earnings per share
Dividend cover
Profit after tax and preference dividends / Paid and proposed ordinary dividends .
How comfortably are dividends covered by profits.
Measured in a number of times. Higher is more coverage.
Dividend yield
Dividend per share / market price per share x 100
Measures the annual return received by way of dividend, the higher the better for shareholders.
High dividend yield may mean the company is not retaining enough profit to invest in future growth.
The limitations of ratio analysis
- They assume the faithful representation within the statements they are based on.
- The year end figures are used, which may not be reflective of common practice throughout the year.
- Inter-company comparisons may be invalidated. Each company may apply different accounting policies.
- Inflation, safe levels.
