3.4 interpreting published accounts (part 2) - moodle

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Interpreting published accounts (Part 2)

By the end of this lesson you should be able to:

1. Understand how to select, calculate and interpret financial ratios to assess performance.

2. Explain the value and limitations of ratio analysis in measuring a businesses performance.

Learning Objectives

TASK 2 – Profitability Ratios

Gross Profit Margin Operating Profit Margin

(OPM) ROCEComplete the Comparing Two Companies activity.

Let’s practice from last lesson!

TASK 1 – Liquidity Ratios

Current Ratio Acid Test Ratio

Complete the Thomas Cook Group case study.

LIQUIDITY RATIOS(The Acid Test)

Remember….

The acid test ratio accepts that it may not be able to convert all stock into cash – Why?

What can they do/ use? Sell Debts – ‘debt factoring’ Cash at bank Sell a non-current asset Consider just-in-time production.

Financial Efficiency Ratios

In order to become profitable and remain liquid, firms must carefully choose debtors, creditors and stock and monitor their efficiency.

Four common measures: Asset Turnover Inventory (Stock) Turnover Payables (Creditor) Days Receivables (Debtor) Days

FINANCIAL EFFICIENCY RATIOS(Asset Turnover)

Measures how efficiently assets have been used to generate sales revenue. Businesses generally aim to achieve a high turnover to show assets are working hard for the company.

Asset Turnover = Sales

Net Assets

Asset Turnover = £1,495 = 1.70

£1,400 This means that for every £1 invested in assets, the business was able to

generate sales of £1.07 in one year.

This figure can vary from business to business depending on the industry and can be used to make comparisons to other organisations.

FINANCIAL EFFICIENCY RATIOS(Inventory or Stock Turnover)

Measures how many times a business turns over its inventories in a year. A high turnover indicates that a firm is selling inventories frequently to generate revenue.

Cost of sales = number of times stock is turned over in the year

Inventory£10,000 = 50 times per year

£200

This means that the Business is selling its inventory 50 times per year – this may mean that it needs to reorder stock 4 timer per month.

What do you think would be an acceptable rate of Inventory Turnover

for the following Businesses?

Calculate the Asset Turnover ratio and Inventory/ Stock Turnover ratio for Alquimia Plc.

What can you infer from the analysis?

Your turn!

Where does the information come

from?

FINANCIAL EFFICIENCY RATIOS(Payables (Creditor) Days)

Measures the amount of time it takes to pay for supplied purchases on credit.

Payables Days = Payables (Creditors) x 365

Credit Purchase

Payables Days = £38,500 x 365 = 35 days (app)

£400,000

If the credit purchase figure is not available, cost of sales, can be used instead. In this example, it takes just over one month to pay suppliers.

FINANCIAL EFFICIENCY RATIOS (Receivables (Debtor) Days)

Measures the number of days it takes to receive payment from customers.

Debtors Payment Period = Accounts Receivable (Debtors) x 365

RevenueDebtors Payment Period = £50,000 x 365 = 52 days

£350,000

This means on average, this organisation can expect to receive payment for sales in 52 days.

Calculate the Payables (Creditor) Days ratio and Receivables (Debtor) Days ratio for Alquimia Plc.

What can you infer from the analysis?

Your turn!

Where does the information come

from?

Gearing Ratios

There is only one gearing ratio.

It measures the percentage of a firms capital that is financed by long-term loans or – compulsory interest generating sources that the company has to pay interest on regardless of profit.

Gearing Ratio

Measures the percentages of capital employed comes from non-current liabilities.

Gearing Ratio % = Non-current Liabilities x 100

(Total Equity + Non-current liabilities) Debtors Payment Period = £2,735 x 100 = 64%

£4,254

This means that for every £ invested in the business, 64p is from non-current/ long-term liabilities where interest payments are compulsory.

If the interest rate increases then businesses are at risk of loan payments increasing.

Calculate the Gearing ratio for Alquimia Plc.

What can you infer from the analysis?

Your turn!

Where does the information come

from?

LIMITATIONS

Accuracy of financial documents – may have been ‘window dresses’

The balance sheet is a ‘snapshot’

Only show financial performance and not the bigger picture – what an investor may be looking for!

What are the Value and Limitations of Ratio Analysis?

VALUES

Help analyse financial documents

Provide structure and put figures in context

Provide a framework for meaningful comparisons

Provide management with a tool to monitor and set targets

Balance Sheet Bingo

Re-cap Learning Objectives

By the end of this lesson you should be able to:

1. Understand how to select, calculate and interpret financial ratios to assess performance.

2. Explain the value and limitations of ratio analysis in measuring a businesses performance.