Analysis and interpretation of financial ratios PDF

Preview

Summary

Teacher Archan Mehta. Number crunching of business figures....

Description

Sam Carpenter BM4117 Lecture, 16/02/16 Analysis and interpretation of financial ratios Ratios are preferred to figures from the financial statements because: they are relative measures of performance. The types of ratio categories; -

Performance or profitability ratios Liquidity ratios Working capital ratios Gearing ratios Investor ratios

Profitability ratios Return on Capital Employed (ROCE) Profit before interest and tax (PBIT) x 100 Capital employed Or Profit before tax (PBT) x 100 Capital employed -

Results are in % form PBIT – earnings before returns to lenders and the government Capital employed – net assets or non-current liabilities and shareholders’ funds It measures the profit on each £ invested and shows productivity/efficiency

Profitability has declined, then investment will decline too. On the other hand, if the profit has increased then the investors will have a bigger share. Profitability ratios Profit before tax x100 Sales Gross profit is the first profit before any overheads. If sales go up the ratio will go up.

Net asset turnover = sales revenue (operating revenue) Capital employed -

Result in times Using assets to generate profit How efficiency assets are used to generate profit Asset turnover x net profit margin = ROCE

Sam Carpenter BM4117 Lecture, 16/02/16 Liquidity ratios Current ratios = Current Assets Current liabilities Current ratio – compares current assets with current liabilities. Current assets are expected to become cash within one year, current liabilities are expected to be paid out in cash within one year. To remain solvent (liquid), the entity must pay its

Quick (Acid test) = Current assets – closing inventory Current liabilities The results will be in times or £. This ratio must be between 1-1.5 to be sufficient.

Efficiency ratios Stock (inventory) holding period (days)

=

Stock (inventory) x 365 days Cost of sales -

Results are in days Shows average length of time cash is ties up in the stock Long? Not selling?

Or

Stock Turnover = operating revenue/turnover Stock

Debtors (trade receivables) collection period = Debtors (trade receivables) x 365 days Credit sales (or operating revenue)

Sam Carpenter BM4117 Lecture, 16/02/16 - Results are in days - Shows average length of time credit customers took before making payment - Only connected with credit sales Creditors (trade payables) payment period/credit period = Creditors (trade payables)

x 365 days

Credit purchases

Or Creditors (trade payables) x 365 days Operating revenue -

Result in days Shows average length time the company is taking to make the payment to its suppliers

Gearing ratios Gearing/financial leverage/capital structure ratios Debt to equity ratio: proportion of capital sourced from debt and equity (next week) -

Debt x 100 Equity (money provided by shareholder)

-

Debt x 100 (debt + equity)

Or

Information on the relationship between the exposure of the business to loans as opposed to share capital. The higher the ratio the more the business is exposed to interest rate fluctuations and to having to pay back interest and loans before being able to re-invest earnings.

Interest cover (no of claims) = PBIT FINACE COSTS Investor ratios Earnings per share (EPS) in pence = Profits distributable to ordinary share holders...