Ratio Analysis

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• Ratio Analysis

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Use of Ratio Analysis

• To analyse
• Performance
• Liquidity
• Shareholders

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Performance Ratios

• ROCE
• Gross profit margin
• Net profit margin

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ROCE
Return On Capital Employed - relates a firms
profitability in relation to the investors
capital investment ROCE profit before tax
and interest 100 long term capital

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Gross Profit Margin
The mark-up. This shows the gross profit made
on sales turnover. Gross profit margin
gross profit 100 turnover A
large range of profit might effect the true
results Useful when comparing against the margins
of previous years.
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Net Profit Margin
This shows how well a business controls its
overheads Net profit margin Net profit
before tax 100 turnover
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Liquidity Ratios
Current ratio
Acid test ratio

• Measure a firms ability to meet short-term
  obligations, collect receivables, and maintain a
  cash position
• How well is the organisation able to meet its
  short-term obligations?

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Current Ratio
(Liquidity ratio ) (Cash asset ratio) (Cash
ratio) Measures a company's ability to pay
short-term obligations. Current ratio current
assets current liabilities A ratio under 1
suggests that the company  might be heading for
bankruptcy
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Acid Test Ratio
(Quick ratio) (Liquid ratio) Determines risk
that is not detected by the Working Capital
ratio Acid test ratio Current Assets - Stock
Current Liabilities An extreme version of the
working capital ratio because it only uses cash
and equivalents. The ratio excludes inventory,
which for some companies can make up a large
portion of its assets.
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Gearing Ratio
Compares owner's equity (or capital) to borrowed
funds. Shows how risky a company is. Gearing
ratio Long terms loans 100 Capital
employed
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Shareholders Ratios

• Earning per share
• Return on equity

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Earning per Share
(EPS) This measure expresses how many
pence the company is earning for every share
held. Earnings per Share Net profit after
tax No of ordinary shares
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Return on Equity
ROE A measure of how well a company used
reinvested earnings to generate additional
earnings ROE to a fiscal year's after-tax
income 100 divided by book value
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Advantages of Ratio Analysis

• Can assist in interpreting and evaluating income
  statements and balance sheets by reducing the
  amount of data contained in them to a workable
  amount
• Can make financial data more meaningful
• Help to determine relative magnitudes of
  financial quantities
• Help managers or business analysts make effective
  decisions about the firm's credit worthiness
• Can assist with predicting potential business
  earnings
• Can assist in seeing financial business strengths
  
• Can assist in spotting business weaknesses

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Factors Affecting Ratio Analysis

• Inflation
• External factors eg pollution
• Management changes
• Yearly comparisons
• Performance
• State of the economy
• Performance of competitors