Ratio Analysis Business and Management, SL

U56 – Ratio Analysis

Ratio Analysis Internal Users Owners, Managers, Employees External Users Potential Investors, Competitors, Creditors Shareholders

Ratio Analysis Efficiency/Activity Ratios Measure day to day activities and how a business employees it’s resources Performance Ratios Measure profitability Shareholder’s Ratios Help investors make decisions about buying/selling shares of stock Liquidity Ratios Measures a firms ability to meet it’s liabilities, or pay its bills

PERFORMANCE Gross Profit Margin Net Profit Margin Return on Capital Employed

AKA Return on Investment % of investment that is PROFIT Compares profit with investment Net Profit before Tax and Interest x100 Capital Employed Capital Employed = Capital & Reserves + Long term liabilities

ROCE - continued Is the rate of profit higher than the existing rate of interest? Depends on industry standards, state of the economy, size and age of the firm Higher % is better

Gross Profit Margin Compare gross profit with sales revenues Indicates a firm’s mark-up Higher % is better Depends on industry Gross Profit x 100 Sales

Net Profit Margin Compare net profit with sales revenues % of profit on each unit sold Helps measure control on overheads Higher % is better Depends on industry Net Profit x 100 Sales

LIQUIDITY RATIOS Current Ratio Acid Test / Quick Ratio

Current Ratio Measures a firm’s cash management and ability to pay its debts If  1.5 the firm has too little working capital If  2.0 the firm has cash that should be invested elsewhere Current Assets Current Liabilities

Acid Test / Quick Ratio Stricter measurement of a firm’s cash management and ability to pay its debts Stock is not always sold right away If  1 the firm has too little working capital If  1 the firm has cash that should be invested elsewhere Current Assets - Stock Current Liabilities

EFFICIENCY/ACTIVITY RATIOS Gearing Ratio Debt CollectionDebt Payment Stock Turnover

Measures how quickly a firm sells stock Compare to industry standards Cost of Sales= # of times Stock ____365____= # days # of times

Debt Collection Measures how efficiently a firm collects from its customers Lower is better Compare to firm’s targets and industry standards Debtorsx 365= # Days Sales Revenue

Debt Payment Measures how efficiently a firm pays its creditors Compare to firm’s targets and industry standards Credit terms can be 30, 60, 90, days! Creditorsx 365= # Days Purchases

Gearing Ratio Indicates the % of a firm’s equity that is borrowed  50% the firm is low geared or a majority is invested by owners  50% the firm is high geared or a majority is borrowed Long Term Liabilities x100 Total Capital Employed Capital Employed = Capital & Reserves + Long term liabilities

SHAREHOLDERS RATIOS Earnings Per Share Return on Equity Dividend Yield

Earnings Per Share Measures how much profit (£, $, etc) each share earns. Does not guarantee dividends. Most profit generally is held in reserves. Net Profit (after tax) # of Shares

Return on Equity Represents % of equity that is net profit. Higher is better. Compare with industry norms. Net Profit (after tax) x 100 Ordinary Shares + Reserves (shareholder equity)

Dividend Yield Represents the % of the current share price that is paid in dividends. Share price is not consistent! Dividends Per Share x 100 Market Price Per Share