Ratio Analysis Flashcards
What is the purpose of ratio analysis and where is the main amount of information found.
To create a figure in order to be able to compare business performance and identify key areas in the business that need improving. Information to work out the ratios is found in a balance sheet, income statement and a statement of financial position
Types of ratios.
Financial efficeny
Liquidity
Profitability
Profitability ratios
Gross profit margin
Net profit margin
Operating profit margin
Return on capital employed (ROCE)
Net profit margin formula
Net profit
—————— X 100.
Sales revenue
Operating profit margin
Operating profit - Profit before the expenses of taxation
Operating profit
——————- x100
Sales revenue
Gross profit margin
Gross profit
—————— X100
Sales revenue
Return on capital employed
Operating profit
————————————————
(Total equity + Non - current liabilities.)
Liquidity ratios
Current ratio
Acid test ratio
Current ratio
Current assets
———————
Current liabilities
Acid test ratio
(Current assets - stock)
——————————
Current liabilities
2.5% or higher is considered a good result
Financial efficiency ratios
Debtor days
Creditor days
Gearing ratios
Inventory turnover.
Debtor days
Debtors
———— X 365
Revenues
Creditor days
Creditors
—————- X365
Cost of sales
Gearing ratios
Non current liabilities (Loans)
——————————————— X100
(Total equity + non current liabilities)(Loans)
Cost of sales
—————————————-
Average inventories (stock held.)
Limitations of current ratios
Varies due to the type of business
Firms have different inventory holding requirements
The trend shows more rather than the initial result
A figure of 2.5% or more is considered good in acid test ratios
Limitations of ROCE
Varies again between industries
Comparisons over tine are more useful
Gearing ratios limitations and indicators
Depends on the business
50% is too high
20% is too low
Financial ratios limitations and indicators
Payable days need to be higher than receivable days
Too high suggests liquidity problems
Limitations of ratio analysis in general
Based on the past
Data can be manipulated
One set of data is never enough
Comparability between businesses.
Purpose of ratios and specific purposes
Used to measure different types of business performance
How is the business trading
Is the business in a strong financial position
Prospects for the business
Profitability
—————
Is the business making a profit
Status of investment
Sustainable
Quality
Financial efficency ———————— Best use of resources Generating adequate returns on investment Managing its working capital properly
Liquidity and gearing ————————— Short term debts payable? Raising enough finance how risky is financial structure Generating enough cash
Shareholder return
————————
What returns are the owners getting
How does it compare to other businesses
Shareholder Ratios
Dividend per share
Total dividends
——————————————
Number of issued ordinary shares
Dividend per yield
(Ordinary share dividend in pence)
(——————————-) X100
(Current market in pence)7
Capital employed
Net assets + long term liabilities
Asset turnover
Revenue
——————-
Net assets
