Part 7: Chapter 47 An introduction to the analysis and interpretation of accounting statement By: Nenae 11gs

What are ratios use for? To compare business whether which are getting more profit

Who are interest in these ratio? Shareholders Lenders Customers Suppliers Employees Government Competitors

Categories of ratio Profitability ratios Liquidity ratios Efficiency ratios Shareholder ratios Capital structure ratios Other ratios

Profitability ratios (as percentage) 1. Return on capital employed (ROCE) = net profit x 100 capital employed This show how successful managers are at earning a profit from capital used in the business. For every $ invested, the business make …% extra. 2. Gross profit margin = gross profit x 100 sales This show how much gross profit is made for every $ earned. For every $ make from sales, …% kept as gross profit margin. 3. Net profit margin = net profit x 100 This show how much net profit is made for every $ earned. For every $ make from sales, …% is kept as net profit margin.

Liquidity ratios 1. Current ratio = current assets current liabilities This show how many times a business can pay its short term debts. 2. Acid ratio test = current assets – stock Similar to current ratio, however without stock because some business may find it difficult to sell stock quickly.

Efficiency ratios 1. Inventory turnover (times) = cost of sales average inventory This measure how efficient a business is at maintaining an appropriate level of inventory. 2. Accounts receivable/ sales ratio = 1: … then translate into length of time a debtor takes to pay: 365 x 1 = …days … 3. Accounts payable/purchases ratio = 1: … then translate into length of time we take to pay out creditors: 365 x 1 = …days

Shareholder ratios 1. Earnings per share (EPS) = net profit after interest and tax and preference dividends number of ordinary shares issued This gives the shareholder a chance to compare one year’s earnings with another in terms easily understood. 2. Price/earnings ratio (P/E) = Marketing price per share earnings per share The greater the P/E ratio, the greater demand for the shared. 3. Dividend yield = Gross dividend per share market price per share This measure the real rate of return by comparing the dividend paid to the market price of a share. 4. Dividend cover = net after tax and preference dividends ordinary dividends paid and proposed This gives the shareholder some idea as to the proportional that the ordinary dividends bear to the amount available for distribution to ordinary shareholders. If the dividend is to be 3 times covered, this means that one-third of the available profits is being distributed as dividends

Capital structure ratios -Gearing = long term loans + preference shares x 100 ordinary share capital + reserves + preference shares + long term liabilities Or in shorter formula Prior charge capital x 100 total capital

Other ratios 1. Operating profit/loan interest 2. Total external liabilities/shareholders’ funds 3. Shareholders’ funds/total assets

Fixed and variable costs Fixed costs are the cost which remain constant. This do not matter whether the activity increase or decrease. Variable costs are the cost that change due to the increase or decrease of the activity

Questions…. ?

1g). a/c receivable/sales ratio 1h). a/c payable/purchases ratio Income Statement $ Sales 555,000 Less: COGS 100,000 opening inventory 200,000 add: purchases 300,000 (60,000) less: closing inventory (240,000) gross profit 315,000 Less: depreciation 5,000 wages, salaries, commission 165,000 other expenses 45,000 (215,000) Net profit Statement of financial position non-current asset equipment at cost 50,000 less: depreciation to date (40,000) 10,000 current asset inventory 60,000 a/c receivable 125,000 bank 25,000 210,000 total assets 220,000 current liabilities a/c payable (104,000) net assets 116,000 financed by:- capital balance at start of year 76,000 add: net profit 176,000 less: drawing total capital Calculate: 1a). ROCE 1b). Gross profit margin 1c). Net profit margin 1d). Inventory turnover 1e). Current ratio 1f). Acid test ratio 1g). a/c receivable/sales ratio 1h). a/c payable/purchases ratio 1a). 100,000/(76,000+116,000/2) = 104.2% 1b). 315,000/555,000x100 = 56.8% 1c). 100,000/555,000x100 = 18% 1d). 240,000/(100,000=60,000/2) = 3 times 1e). 210,000/104,000 = 2.02 1f). 145,000/104,000 = 1.39 1g). 125,000/555,000x12 = 2.1 months 1h). 104,000/200,000x12 = 6.24 months

Net profit after interest and tax and preference dividends = $300,000 Number of ordinary share issued = $500,000 Market price per share = $4.20 Gross divided per share = $20 Interest = $10,000 Ordinary dividends paid and proposed = $120,000 2a). 300,000/50,000 = 60 2b). 4.20/0.6 = 7 2c). 0.20/4.20 = 4.76% 2d). 300,000 + 10,000/120,000 = 2.58 times 3).30,000/210,000 = 14.3% Calculate: 2a). Earnings per share 2b). Price/earnings ratio 2c). Dividend yield 2d). Dividend cover 3). If prior charge capital = 30,000 and total capital = 210,000, what is the gearing?