Download Interpretation of Accounts Ratio Analysis

Interpretation of
Accounts
Ratio Analysis
http://www.bized.ac.uk/compfact/ratios/
index.htm
The need for ratios
To examine the profitability of the firm.
To find out the ability of the firm to meet it’s
debts (liquidity).
To see how efficiently the managers of the
firm uses its resources.
So that investors in the firm can see the
returns on their investment.
Profitability Ratios: ROCE
Return On Capital Employed (ROCE)
Net profit before tax & interest
Total capital employed
Expressed as a percentage
X 100
Using ROCE
Larger figures indicate higher profitability
Must be compared with previous year or
similar firm to be meaningful.
Profitability Ratios: Gross Profit
Margin
Shows gross profit as a percentage of
sales
GPR =
Gross Profit
X 100
Total sales revenue
Does not show the impact of overheads
on profits.
Profitability Ratios: Net Profit
Margin
Shows net profit as a percentage of sales.
NPM =
Net profit
X 100
Total sales revenue
Should be compared with previous period
or with similar business
Gross & Net profit margins
How are they linked?
If the NP margin goes down more than the
GP margin what does this mean?
Remember, GO and NP are linked in the
profit and loss account, and so they are
linked here!
Liquidity Ratios
Measure the indebtedness of the firm.
Current Ratio =
Current Assets
Current Liabilities
Expressed as a ratio eg 3:1
Not expressed as a percentage!
Ideal value = 1.5:1 or 2:1
Low Current Ratio: Overtrading &
over-borrowing
When the ratio is too low for the firm to
meet its debts.
Overtrading.
High Current Ratio
Suggests the firm is not making full use of
its current assets (eg cash idle in a bank
a/c)
Limitations of Current ratio
Suggests that stocks can be liquidised
quickly, and at a fair value. This is not
always the case. They can become
obsolete or deteriorate.
SO….
Acid Test Ratio
Does not treat stocks as liquid assets
Acid Test Ratio = Current Assets – stocks
Current Liabilities
A value of 1:1 is considered acceptable
Shareholder Ratios
Return on Equity =
Profit after tax, interest & pref. dividends
Ordinary Share Capital
X 100
Shareholder Ratios (cont’d)
Earnings per Share =
Net profit (after tax and Pref. dividend)
Number of shares
This shows how much profit each share has earned for the business.
The directors will use this figure to help decide dividend payments
Shareholder Ratios (cont’d)
Dividend Yield =
Dividend per share
Market value of shares
X 100
Efficiency Ratios
Stock Turnover
This shows how many times over the business has sold the
value of its stocks during the year.
STOCK TURNOVER RATIO = Cost of Goods Sold
Average Stock
(Sometimes Sales is used if Cost of Goods Sold not
available)
Efficiency Ratios
The higher the stock turnover the better,
because money is then tied up for less
time in stocks. A quicker stock turnover
also means that the firm gets to make its
profit on the stock quicker, and so the firm
should be more competitive.
However, it will vary between industries and
so it is important to compare within an
industry, as well as from year to year.
Efficiency Ratios
Trade Debtor Collection Period =
Trade Debtors
Sales Revenue (Credit)
X 365
A low value means that the firm is managing its debtors
well. A higher value indicates that debtors are taking
longer to pay. The firm would need to investigate this
further.
Efficiency Ratios
Trade Creditors Payment Period =
Trade Creditors
Total purchases
X365
A longer period means that it is taking the business longer to pay its
debts to its creditors. This could be an advantage (ie free credit) or
indicate a problem (lack of money to make payments!). It can also
prove disastrous as it may force suppliers into bankruptcy.
Efficiency Ratios
Gearing Ratio
Loan capital (+ Preference Capital)
X100
Total Capital
A higher % means that the firm must pay more interest on
profits each year. Failure to do so could lead to
insolvency. A lower % is preferable since shareholders
will only be paid a dividend out of profits if the directors
feel that the firm can afford it.