Ratios!

Interpreting Published Accounts

All the ratios involved in interpreting business Balance Sheets and Income Statements

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Liquidity

'The Objective of a financial account is to provide information that is useful to a wide range of users in making economic decisions.'

Liquidity is a firms ability to meet day-to-day expenditure.

Two common measures of liquidity are the current ratio and acid test ratio.

Current Ratio = Current Assets (BS) / Current Liabilities(BS)

(aka the working capital ratio)

Ratio of between 1.5-2.0 would suggest efficient management of working capital.

Acid Test Ratio = (Current assets(BS)-Inventories(BS))/Current Liabilities(BS)

NB: 'Current assets-Inventories' can also be referred to as liquid assets

Significantly less than 1 is often BAD NEWS!

 

 

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Profitability

The relationship between business's profits and sales revenue.

Two  common measures of profitability:

  • Operating Profit Margin (OPM)
  • Return on Capital Employed (ROCE)

OPM % = Operating Profit (Net Profit) / Sales Revenue (IS) x 100

ROCE % = 'A measure of how efficiently a business is using its capital to generate profits.'

          Operating Profit (Net profit) / (total equity + Non-current liabilities(BS)) x 100

Capital Employed: = total equity + non-current liabilities. It is the total capital invested in the business from long term sales.

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Financial Efficiency Ratios

Asset Turnover measures how effectively a business is using its assets to generate sales

= Sales (IS) / Net Assets(BS)

The number given by the equation is how much is generated from sales for every £1 invested in assets.

  • Less relevant for labour-intensive businesses
  • Will vary from industry to industry
  • Can fluctuate from year to year (e.g major investment in fixed assets in one year generates increased sales in the following years)

Inventory (Stock) Turnover 

'A measure of how many times per year a business turns over its stock through sales.'

= Cost of sales (IS) / Inventory (BS).

  • Will vary from industry to industry
  • Seasonal fluctuations in the year may not be reflected in calculation
  • Irrelevant for many service sector businesses
  • Holding more stock may improve customer services.

High number is better! Low Number suggests poor stock control

 

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Financial Efficiency Ratios Continued...

Stock Turnover can be Improved by:

  • Sell off or dispose of slow-moving obsolete stock
  • Rationalise product range
  • introduce lean production techniques

Payables (Creditor) Days: a measure of the average number of days taken to pay suppliers.

=(Payables(BS) x 365 days) / Credit purchases (Stated)

If the figure for 'Credit Purchases' is not available, 'cost of sales' is used instead.

Higher figure is better!

Receivable (Debtor) Days: a measure of the average number of days a business takes to collect its debtors from its customers.

=(Receivables(BS) x 365 days) / Revenue (IS)

Each Industry has a 'NORM'

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Gearing

Gearing Ratio: The % of capital employed that comes from non-current liabilities.

= Non-Current liabilities(BS) / ( Total Equity(BS) + Non-Current Liabilities(BS)) x 100

  • Focuses on the long-term financial efficiency of the business.
  • High gearing ( above the 50% THRESHOLD suggest potential problems in financing)

 


 

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Share Holders

Shareholder ratios are ratios that help measure the value of the return received by shareholders.

Dividen per Share (DPS): The number of pence per share recieved by shareholders

= Total Dividends / Number of issued shares

Dividened Yield: a measure of the return received on an investment, expressed as a % of the current market price of the share.

= ( Dividend per share / Market share price) x100

 

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Financial Data - Income Statement (IS)

Income statement is a financial document that sumarises a business's tarding activity and expenses to show whether it has made a profit or a loss.

Gross Profit: profit after cost of sales has been deduced

Operating Profit: Profit after all other expenses have been deducted, also referred to as net profit.

Gross Profit Margin: gross profit expressed as a % of sales revenue.

Operating Profit Margin: operating profit expresed asa % of sales revenue. 

NB Profit quality is the sustainability of profit where as Profit Utilisation is how the profit is being used.

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Financial Data - Balance Sheet (BS)

Its a financial document that summarises the net worth of a business - it balances TOTAL ASSETS with TOTAL EQUITY & LIABILITIES.

Some of the KEY TERMS Included in  a BALANCE SHEET.

Total equity: the total amount of money being utilised in the business from share capital and retained profit.

Non-Current Assets (Fixed Assets): items of value owned by the business that are likely to be kept for more than 1 year.

Current Assets: resources owned by the business whose value varies as a result of daily business activities.

Current Liabilities: financial obligations of the business payable within 12 months.

Non-Current Liabilities (long-term liabilities): debts that the business has more than a year to pay.

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Balance Sheet Continued....

Working capital: a measure of a firm's ability to meet ability to meet day-today expenses.

Depreciation: an accounting practice which allows the value of a fixed asset to be spread ovr its useful life.

Trade receivables: amounts owed by debtors to the business.

Debtor: someone who owes the business money.

Trade Payables: Amounts owed by the busiess to creditors.

Creditor: Someone the business owes money to.

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