Managing Finance and Budgets Seminar 4

Seminar Four - Activities  Preparation: read Chapter 7 (M & A 2 nd Edition) Or Chapter 6 (M & A 1 st Edition)  Describe key concepts: Analysing accounts Ratios Exercises:  M & A (2 nd Ed.) Exercise 7.3 (pages ) and Exercise 7.5 (pages )  Or M & A (1st Ed.) Exercise 6.3 (pages ) and Exercise 6.5 (pages )

Starting Points  Describe what is meant by Financial Ratio Analysis, and outline the key steps in performing such an analysis.  State some of the things we need to consider when we are examining accounts, and some of the factors which might affect such our analysis.

Select and calculate appropriate ratios Identify users and their information needs Interpret and evaluate the results The key steps of financial ratio analysis

Key Ratios  State the different categories of financial ratio that can be used in analysing accounts, and describe the purpose of each one.  State some of the measures within each category.

Financial ratio classification Categories Profitability Efficiency Liquidity Gearing Investment

Profitability Return on ordinary shareholders’ funds Return on capital employed Net profit margin Gross profit margin Formula Net profit after taxation and preference dividend (if any) x 100 Ordinary share capital + Reserves Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans Net profit before interest and taxation x 100 Sales Gross profit x 100 Sales Sales

Efficiency Average stock turnover period Average settlement period for debtors Average settlement period for creditors Sales to capital employed Formula Average stock held x 365 Cost of sales Sales per employee Trade debtors x 365 Credit sales Trade creditors x 365 Credit purchases _______Sales_______ Number of employees _______ Sales__________ Long-term capital employed

The main elements comprising the ROCE ratio Sales______ Long-term capital employed Return on capital employed multiplied by equals Net profit before interest and taxation sales

Liquidity Current ratio Acid test ratio Operating cash flows to maturing obligations Formula Current assets_______________ Current liabilities (creditors due within one year) Operating cash flows Current liabilities Current assets (excluding stock) Current liabilities

Gearing ratio Interest cover ratio Formula Profit before interest and taxation_ Interest payable Long-term liabilities _______ Share capital + Reserves + Long-term liabilities Gearing

The effect of financial gearing

Investment ratios Dividend per share Dividend payout ratio Dividend yield ratio Earnings per share Formula Dividends announced during the period Number of shares in issue Operating cash flow per share Dividends announced for the year x 100 Earnings for the year available for dividends Dividend per share/(1-t) x 100 Market value per share Price/earnings ratio (P/E) Earnings available to ordinary shareholders Number of ordinary shares in issue Operating cash flows – preference dividends Number of ordinary shares in issue Market value per share Earnings per share

Calculating and Using the Ratios (1)  What are the criteria that an investor should look for when selecting a company in which to invest?  McLaney & Atrill Exercise 7.3 (6.3 1 st ed)

Dividend yield ratios Source: Financial Times 31 May Oil exploration and production Building and construction Chemicals Engineering Pharmaceuticals Tobacco Food retailers Electricity Water Distribution Media Retail banks

Average P/E ratios Source: Financial Times 31 May 1997 Oil exploration and production Building and construction Chemicals Engineering Pharmaceuticals Tobacco Food retailers Electricity Water Distribution Media Retail banks

Calculating and Using the Ratios (2)  What criteria should a supplier look for when deciding whether to supply a business customer?  McLaney & Atrill Exercise 7.5 (6.5 1 st ed)

Average current ratio and average acid test ratio for 1996 for UK listed companies in various industrial sectors Mineral extraction 0.0 General industries Consumer goods Services Utilities Current ratio Acid test ratio

Current ratio Time 19X119X4 19X319X2 19X5 XYZ Ltd Industry average Graph plotting current ratio against time

Calculating and Using the Ratios (3)  What early-warning signs can be detected that a company may be heading towards insolvency and failure?

Mean ratios of failed and non-failed businesses

Scatter diagram showing the distribution of failed and non-failed businesses Current ratio ROCE ratio Failed businesses Non-failed businesses