Ratio Analysis Purpose: To identify aspects of a business’s performance to aid decision making Quantitative process – may need to be supplemented by qualitative factors to get a complete picture

5 main areas: Liquidity – the ability of the firm to pay its way Gearing – information on the relationship between the exposure of the business to loans as opposed to share capital Profitability – how effective the firm is at generating profits given sales and or its capital assets Financial – the rate at which the company sells its stock and the efficiency with which it uses its assets Investment/shareholders – information to enable decisions to be made on the extent of the risk and the earning potential of a business investment

Shareholder/Investor Ratios A prime concern of shareholders is their return on investment.  The returns from investing in shares of a company come in two main forms: The payment of dividends out of profits The increase in the value of the shares (share price) compared with the price that the shareholder originally paid for the shares

Two Investor Ratios to know: Dividend per share (in pence) total dividends number of issued ordinary shares Dividend yield (%) ordinary share dividend (in pence) x 100 current market price (in pence)

Dividend Per Share This shows the value of the total dividend per issued share for the financial year. But what else do we need to know? How much the shareholder paid for the shares – i.e. what the dividend means in terms of a return on investment How much profit per share was earned which might have been distributed as a dividend

Dividend Yield A dividend yield of 6.5% would seem to be a good return in a period of low interest rates and low returns on savings accounts.  But what else do we need to know? whether the shareholders consider it to be an acceptable return for the perceived risk investing in the shares of the business.

Book Exercise

Questions Give two reasons why the dividend yield of a business may go up. (2) dividends per share rise share prices fall   State two factors that may determine whether a company pays a bigger dividend than other similar companies. (2) Profits may rise and so shareholders may vote to raise dividends in proportion. Shareholders may vote to pay out a bigger proportion of profits as dividends. Explain why the dividend yield is a useful ratio for investors. (2) It shows what percentage of the share price is returned in dividends, so this can easily be compared with the return on alternative investments.