financial ratios Flashcards
what is Ratio analysis
Ratio analysis involves comparing one figure against another to produce a ratio,
and assessing whether the ratio indicates
a strength or a weakness in a company’s’ affairs
what should ratio analysis consist of ?
Ratio analysis should incorporate comparative information including
ratios within the same company over time to try to identify a trend, comparison of ratios with similar companies to assess how a company is performing relative to its’ competitors.
what is the objective of financial statements ?
The objective of financial statements Is to provide information about the financial position, performance and financial adaptability of an enterprise that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions.
where can you find financial information
Financial Position obtained from a
Balance Sheet
Performance-
from the Income Statement,
Statement of recognised gains and losses,
Cash Flow Statements
Financial adaptability-
All four of the above, financial adaptability
is the ability of the enterprise to react,
alter, adapt, to respond to unexpected events
and opportunities.
The main users and their information
needs are identified as……..
WHO?
Investors
As the providers of risk capital to the enterprise,
are interested in information that helps them to assess the
performance of management.
They are also concerned with the risk inherent in,
and return provided by, their investments, and need
information that helps them to assess the ability of the
enterprise to pay dividends, and to determine whether they
should buy, hold or sell their investments.
Employees
Are interested in their livelihood-
are interested in information about the stability
and profitability of their employers.
The ability of the enterprise to provide remuneration,
employment opportunities and retirement benefits.
Lenders
Are interested in information that enables them to
determine whether their loans will be repaid,
and the interest attaching to them paid when due.
Suppliers and Other Creditors
Are interested in information that enables them
to decide whether to sell to the enterprise and to
assess the likelihood that amounts owing to them
will be paid when due.
Trade Creditors are likely to be interested in an
enterprise over a shorter period than lenders unless
they are dependent upon the continuation of the
enterprise as a major customer.
Customers
Have an interest in information about the
continuance of an enterprise, especially when they
have a long-term involvement with,
or are dependent on, the enterprise.
Government and their agencies
Are interested in the allocation of resources and,
therefore, the activities of an enterprise.
They also require information in order to regulate
the activities, assess taxation and provide a basis
For national statistics.
The public
Enterprises affect members of the public in a
variety of ways.
They may make a substantial contribution to a
local economy by providing employment and
using local suppliers-
creating other small businesses/ local employment.
RATIOS
There are endless numbers of ratios that could be calculated, and the subject area is constantly developing- the most recent trends towards non-financial data, and more detailed reports.
The calculation of ratios is a starting point for the interpretation of a set of accounts, but calculation of the ratios is only one part of the process of reviewing performance.
Ratio analysis on its’own is insufficient to allow a full interpretation of company accounts
RATIOS In addition:
-some sort of SWOT analysis is required-
Strengths, Weaknesses, Opportunities and Threats.
-Review of Directors Report, Chairman’s Statements
GROSS PROFIT MARGIN
Gross Profit Margin
Gross Profit x 100 = X%
TURNOVER
Gross Profit earned from £1 of sales
OPERATING MARGIN
Operating Margin Percentage
Operating Profit x 100)
TURNOVER
Net Profit earned from £1 of sales
ROCE
Return on Capital Employed
Operating Profit x 100
Total Capital Employed*
* Equity(shares) + Long Term Loans (Debt)
Return on the funds invested in the business
Considered being one of the most important ratios
RETURN ON SHAREHOLDERS FUNDS
Return on Shareholders Funds
Profit Available to Shareholders x 100)
Shareholders Capital Employed*
* Equity(shares)
Return on the funds invested in the business
Considered being one of the most important ratios
INVENTORY TURNOVER
.Inventory Turnover
Average Stock** x 365 = x no of days
Cost of Sales
Rate at which stock moves through the business
NET ASSET TURNOVER
Net Asset Turnover
Turnover = X no. of times per year
Total Net Assets (capital employed)
Measures how hard fixed assets are working
RECEIVABLES COLLECTION
.Receivables collection
Trade Receivables x 365 days = x no.of days
Turnover
Time taken by debtors to pay their invoices
PAYABLES PAYMENT
Payables payment
Payables x 365 days) = x no.of days
Cost of Sales
Time taken to pay creditors to pay their bills.
Care though you may need to refer to the relevant
notes to the accounts!
CURRENT RATIO
.Current Ratio
Current Assets = x
Current Liabilities
Coverage of short term liabilities by short term assets
ideally x should be more than 2
QUICK ACID TEST RATIO
.Quick(Acid test) ratio
Current Assets less Inventory (Stock) = x
Current Liabilities
Coverage of short term liabilities by liquid assets
ideally x greater than 1
BASIC GEARING
.Basic Gearing
Long Term Debt x 100
Total Capital Employed
Percentage of borrowed finance to equity funding
INTEREST COVER
.Interest Cover
PBIT or Operating Profit x 100
Interest Paid
Ability to pay interest out of current profits.
EARNINGS PER SHARE
.Earnings per Share
(Profit attributable to shareholders/ No. Of issued ordinary shares)
The earnings of the company for each share in issue
PRICETO EARNING RATIO
Price–to-Earnings (P/E) Ratio
(Market price per share / Earnings per share)
Markets confidence in the future of the share
DIVIDEND COVER
.Dividend Cover
(Profit attributable to ordinary shareholders/ dividend)
Future security of the shareholders’ current dividend
DIVIDEN YIELD
Dividend Yield
(Gross dividend/ Market price per share x 100)
The percentage cash return for each share held
NET ASSET VALUE
.Net Asset Value
(Net assets/ No.of issued ordinary shares)
A crude measure of the asset backing for each issued share
