Ratio Analysis

A method of assessing a firm’s financial situation by comparing two sets of linked data.

Comparisons Inter-firm comparisons Intra-firm comparisons Comparisons to a standard Comparisons over time

Types of ratio Profitability ratios Liquidity ratios Gearing Financial efficiency ratios Shareholders ratios

Users of ratios Managers Employees Government Competitors Suppliers

Liquidity ratios Measure of a firms ability to meet its day to day expenditure. Does the firm have sufficient short term assets to cover its short term debts.

Current test ratio Current asset ratio = current assets current liabilities 252 = 1:1.5 219 For every £1 of current liabilities, it has £1.15 current assets

Acid test ratio Acid test ratio = (current assets- inventories)/current liabilities 252-42/219 = 1:0.95 For every £1 of current liabilities, it has only £0.95 current assets excluding inventories.

Profitability ratios Allow for the analysis of a firms profits in relation to either its trading performance or the capital utilised in generating that profit

Operating profit margin Operating profit/sales revenueX100 545/1,390X100 = 39% For every £1 of sales, 39p is left as profit after expenses have been paid

Return on capital employed ROCE% = operating profit/(total equity and non current liabilities)X100 545/3034X100 = 17.9% For every £1 capital invested, a profit of 0.179p was generated in that financial year.

Financial efficiency ratios How efficiently are management controlling the financial operation

Asset turnover Measures how efficiently assets are used to generate sales revenue. Asset turnover = sales/net assets 1,390/1,300 = 1:0.7 For every £1 invested in assets, the business was able to generate sales of 0.43 in one year

Inventory/ stock turnover Inventory turnover = cost of sales/inventory 568/42 = 13.5 times The business is selling its inventories 13.5 times per year

Payables (creditor days) Payables days = (payables X365 days)/credit purchases 219X365/845 = 94 days On average the business pays for supplies approximately 3 months after receiving them.

Receivables (debtor) days Receivables days = receivablesX365/revenue 135X365/1390 = 35 days On average the business can expect to receive payment for their sales 35 days after the sale has taken place.

Gearing Measure of the percentage of a firms capital that is financed by long – term loans. Gearing ratio% = non-current liabilities/ (total equity + non-current liabilities)X100 1,734/3034 X100 = 57% For every £1 invested in the business, 57p is from a long-term liability.

Shareholders ratios Measure the value of the return to a shareholder.

Dividend per share DPS = total dividends/number of issued shares 300m/450 = 66.7p For each share owned a shareholder will receive 66.7p.

Dividend yield Dividend yield = (dividend per share/market price) X100 If a dividend of £1 was received, the expected value of the share would be £6.50.

Limitations Firms have other objectives Social audits reliability

Other things to consider Reliability Historical bias Comparisons Corporate objectives External factors