Ratio Analysis

FINANCIAL RATIOS AND MEASURES REVIEW

RATIO ANALYSIS

Ratios can be used as indicators of business health or impending problems. There are two main approaches to ration analysis:

Vertical Comparison of figures within one financial period.

Horizontal Comparison of figures from different financial years.

UNDERSTANDING RATIOS

Ratios must be interpreted after considering the economic and industrial conditions applying to the organisation.

                Ratios should be compared over time to

determine the factors that have caused changes in the results and determine specific trends.

               Ratios should be compared to a reasonable

performance indicator (KPI).                 Ratios can assist to performance analyse any

item or sub total in a profit & loss.

Gross Profit --------------- X 100

Revenue

GROSS MARGIN %

Measures the adequacy of trading

profit or margin

EBIT --------------- X 100

Revenue

PROFITABILITY %

Critical measure of operational performance before tax and interest

COSTOF

SALES

FIXEDCOSTS

VARIABLECOSTS

TAX

SALES

GROSSPROFIT

CONTRIBUTION..

EBIT

NETPROFIT R I

Earnings Before Interest and Tax

DIVIDENDS

PROFITBEFORE

TAX

INTEREST

OUTPUTOUTPUT

TAXTAX

SHAREHOLDERSSHAREHOLDERS

BANKBANKEBIT

Net Profit --------------- X 100

Revenue

NET PROFIT TO SALES

Measures the final net profit rate after tax and

interest

PROFIT MANAGEMENT

Product

Yield

Service

Optimum Volume

Control of Costs

PSYCO

Accounts Receivable

------------------Revenue

ACCOUNTS RECEIVABLE COLLECTION RATE

Measures Accounts Receivable

Collection Rate

X 365

AppropriateTime Period

Accounts Payable

------------------COGS

ACCOUNTS PAYABLE COLLECTION RATE

Measures AccountsPayable Payment

Period

X 365

Inventory------------------

COGS

INVENTORY TURNOVER

Measures the level of inventory turnover(Shelf Life of Stock)

Average Inventory =

Opening Inventory +

Closing Inventory

2

X 365

Current Assets------------------

Current Liabilities

CURRENT RATIO

Basic test of the ability to pay debts

Working Capital % =

Accs Rec. + Inventory –

Accs Pay./ Revenue *

100 * Time Period

Sales--------------- Net Assets

ASSET TURNOVER RATE

How much in sales are generated from each $1 of

capital invested in net assets

_

funds from one periodTo the next

Short Term + Long Term Debt (This period)

Short Term + Long Term Debt

(Last Period)

MeasuresThe change in

externally borrowed

CASH FLOWA negative amountshows that cash flow has

increased.

To get a To Get a Return On Capital Employed

Or ROCE

WHY GO INTO BUSINESS?

Equity

=

Assets

-

Liabilities

Shareholdersfunds

Retained Profits

& reserves

Fixed assets

Debtors

Inventory

Other current assets

Bank overdraft

Other short term debt(eg lease, Hire

purchase & taxation Liabilities)

Cash

Creditors

THE ACCOUNTING EQUATION

THE ACCOUNTING EQUATION

Net Debt + Equity = Total Operating Assets

(Capital Employed)

How the Business How the funds are

is funded = applied in the

business

=

Capital EmployedCapital Employed

Net AssetsNet Assets

DEBT CAPITAL + EQUITY CAPITAL

Operating

Working CapitalNON-CURRENT

ASSETS+

Bank LoansBank LoansBank OverdraftBank OverdraftLeasesLeasesHire PurchaseHire Purchase

Share capitalShare capitalRetained IncomeRetained IncomeReservesReservesOther Equity FundingOther Equity Funding

Accounts ReceivablesAccounts ReceivablesInventoriesInventoriesOther Current AssetsOther Current Assets(Accounts Payables)(Accounts Payables)

InvestmentsInvestmentsIntangiblesIntangiblesBuildingsBuildingsPlantPlantEquipmentEquipment

FINANCEFINANCE

OPERATIONSOPERATIONS

X

Measures Balance SheetManagement

Revenue

Net Operating Assets

EBIT

Revenue

MeasuresProfit and LossManagement

COMPONENTS OF ROCE

X 100

RETURN ON CAPITAL EMPLOYED (ROCE)

• One measure that combines both profit and loss management and balance sheet performance

• Is measured before any financing cost to enable comparisons to be made with the average cost of finance

• Is critical to the assessment of value creation