Using Financial Ratios A2 Business Studies

Aim:  To understand the value and limitations of ratio analysis Objectives:  Recap on financial accounts  Describe the values and limitations of ratio analysis  Analyse and Evaluate the values and limitations of ratio analysis Aims and Objectives

 Define a balance sheet  Define a tpl/income statement  Explain 4 items you may find in each  Define a financial objective  Write the equation to calculate:  Gearing  Liquidity  ROCE  Net Profit Margin  Dividend Yield Starter

 When considering ratio results, the type of business must be considered.  Manufacturers may need high levels of liquidity to enable them to purchase large amounts of stock  Retailers’ figure may be much lower  Jewellers have high profit margins, whereas other industries may have small margins, but sell in vast quantities. Examiners Tip

 In groups brainstorm:  Why firms may use ratio analysis  To what extent is ratio analysis beneficial/valuable for firms to use. Value/Uses of Ratio Analysis ABCDE

1)By using a range of ratios it is possible for an existing shareholder, stakeholder or investor to make direct comparisons with other firms.  E.g. Comparing current ratios of Apple and Microsoft. Values/Uses of Ratio Analysis

2) Liquidity ratios are of particular interest to the management, their suppliers and their creditors to look at the businesses ability to pay its debts. Values/Uses of Ratio Analysis

3) Efficiency ratios provide specific evidence as to how well the management is controlling the business. Of interest to shareholders, managers, employees and competitors. Values/Uses of Ratio Analysis

4) Profitability measures the success of the business. 5) Gearing measures the extent to which the business is running on borrowed money. 6) Shareholder ratios provide vital information to shareholders or investors regarding the rate of return. Values/Uses of Ratio Analysis

 Brainstorm in groups the limitations of ratio analysis Limitations of Ratio Analysis ABCDE

1.Ratios are only really averages 2.Ratios are taken over the whole business which may be concealing parts of the business which are performing badly 3.On its own a ratio tells us nothing. It must be compared with historical data or other firms. 4.Businesses can distort the figures depending on which accounting methods they have used 5.Inflation needs to be taken into account. An increase in sales may hide the fact that no improvements have been made. Limitations of Ratio Analysis

6. The financial statements used only show current performance and do not predict future trends. 7. Ratios need to be looked at in a context of a business, and an industry or they mean nothing. Limitations of Ratio Analysis

 To what extent is this exercise and analysis valuable to the business (18 Marks)  Content  Application  Analysis  Evaluation Case Study