Interpretation of Financial Statements Flashcards
Ratio Analysis - 5 Categories
Shareholder Ratios
Profitability Ratios
Efficiency Ratios
Solvency Ratios
Liquidity Ratios
Shareholder Ratios
These can be used to assess the rate of return on shares and the prospects of shareholders investments
Profitability Ratios
These compare the profits of the business with sales, assets and the capital employed in the business
Efficiency Ratios
These indicate how efficiently a business is using its resources and collecting its debts
Solvency Ratios
These measure the degree to which a business is relying on long-term loans. They reflect a businesses financial strategy
Liquidity Ratios
These measure how easily a business could meet its short-term debts or liabilities
Return On Capital Employed (ROCE)
= Net Profit (Before Tax) / Capital Employed X100
Compares net profit to the amount of money in the business
Higher % the better
Compares with
- previous figures
- Alternative investments
The Gross Profit Margin
= Gross Profit / Turnover X100
Compares gross profit with the value of sales
Higher % is better
Improved by
- Increasing turnover relative to costs
A relative decrease in costs
The Net Profit Margin
= Net Profit / Turnover X100
Compares net profit with the value of sales
Higher % the better
Used to
- Compare performance over time
- Assess how well overhead costs are being managed
Stock Turnover
= Stocks / Cost of Sales X365
Measures how quickly a firm sells its stock
Lower figure the better
Ratio is of little use in the service industry
Debt Collection Period
= Debtors / Turnover X365
Measures how quickly a firm is able to collect money it is owed
Lower the figure the better cash flow will be
Can be improved through better credit control
Creditor Payment Period
= Creditors / Turnover X365
Measures how quickly a firm pays its debts
Higher figure may help improve cash flow
If figure is too high it may
- Indicate cash flow problems
- Lead to problems with suppliers
Asset Utilisation
= Turnover / Net Assets
Measures the turnover that is generated by assets in the business
Higher figure is better
Increasing turnover without buying new assets will improve it
The Gearing Ratio
= Loan Capital / Capital Employed X100
Measures how reliant a firm is on borrowed money
High gearing means higher interest costs
May affect:
- Value of dividends paid to shareholders
- The ability to obtain more borrowed funds
Interest Cover
= Net Profit (Before tax and interest) / Interest Paid
Measures how many times a firm is able to pay its interests costs using net profits
Gives indication of how affordable the borrowing of the firm is
