W2 - Ratio Analysis Flashcards
Why is ratio analysis important?
-The interpretation of financial statements is key to in-depth understanding of performance
-Ratios help to build up a picutre of the position and performance of a business
What are ratios used for?
-Comparison
-Therefore, they must be used in context
What are the types of ratio?
-Profitability
-Efficiency
-Liquidity
-Gearing
-Investor
What are the pprofitability ratios?
-Return on Capital Employed
-Gross profit margin
-Operating profit margin
What is ROCE?
-Fundamental measure of business performance
-Expresses relationshipo between operating profit and average long-term capital invested in the business
ROCE formula
Operating profit / Capital employed x100
Examples of capital employed?
Retained profit, reserves, share capital, share premium and non-current liabilities
Interpretation of ROCE
-Compares inputs with outputs
-Assesses the effectiveness with which funds have been deployed during accounting period
-Ideally ROCE should be higher than the rate of interest
Gross Profit Margin
-Relates gross profit to same period’s sales revenue
-Measure of profitability in buying & selling goods/services before other expenses
Gross Profit Margin formula
Gross profit/Sales x100
Interpretation of GP margin
-Represents what a company made after paying off its COGS
-comanies with high GP margin are more liquid and have more money to spend on indirect expenses
-When raw material costs increase, the GP margin will decrease unless selling prices are increased
Operating Profit Margin
-Relates the operating profit for the period to the sales revenue generated in that period
-Shows not just the margins earned on sales but also the firms ability to control its operating costs
OP Margin formula
OP / Sales x100
Interpretation of OP margin
-If GP margin is stable but OP margin is falling, you need to examine operating costs
-The higher the better; less than 5% means the company is in a very competitive sector or is doing badly
-Variations in operating profit margin over time, usually due to changes in sales mix, selling prices or indirect costs
What are the efficiency ratios
-Non-Current Asset turnover ratio
-Average Recievables Collection period
-Inventory Holding Period
-Average Payables Payment Period
-Net Trade (Operating) Cycle
Non-Current Asset Turnover Ratio
A measure of how effectively the firm is using its long-term asset base to generate sales
NCA turnover formula
Sales / non-Current Assets = ….times
Interpretation: NCA turonver
-Amounts of sales revenue generated per £ of non-current assets
-It is a measure of the level of activity and productivity
-If thr assets are not producing sales, they represent a drain on the companys resources/efficiency
Average Recievables Collection Period
-Measures thr average time takne to collect money from recievables
-Assume all sales are credit sales
Average Recievables Collection Period Formula
Trade Receivables / Credit Sales x365 days
Interpretation: Avrg. receivables collection period
-Businesses will usually prefer short settlement periods
-Where the period is high compared with other businesses, this indicates inadequate credit control
-Normal average around 45-75 days
Inventory Holding Period
-Measures the average time taken to turn inventory into sales (or the length of time inventory is held for)
Inventory holding period formula
Invesntory / Cost of sales x365 days
Interpretation: Inventory Holding period
-Shouldnt be holding inventory for too long
-MAy be distorted by seasonal factors or by major upturns in sales activity
-Too long? - Just in time system?
