Monitoring the Business + - x ÷ ÷ x x ÷ : : : : Ratio Analysis C. O' Brien Chanel College

Learning Targets Understanding the Trading Profit & Loss Account and Balance Sheet Profitability Ratios Liquidity Ratios Gearing Ratio

Who is interested? Shareholders: Profitability ROI Managers: Control expenditure Make decisions Profit Objectives Employees: Profitability – Wages/ job security Lenders: Firms ability to repay debts ROI compared to other options Suppliers: Selling goods on credit versus COD Government: Revenue Commissioners Level of Corporation Tax

3 Financial Statements Trading Account Gross ProfitSales – Cost of Sales = Profit & Loss Account Net Profit = Gross Profit - Expenses Dividend Reserves/ Retained Earnings

Balance Sheet Shows year end value of the company – Assets & Liabilities.

Balance Sheet – Key Words Fixed Assets: Items owned by the business and intended for long- term use e.g. premises Current Assets : Cash or any other assets that can be converted in the short term e.g. stock / debtors/ bank deposits Current Liabilities: Short term debts owed by the business which fall due within one year e.g. Creditors / Bank Overdraft Working Capital = Current Assets – Current Liabilities If CA > CL Business has sufficient cash to cover debts

Net Assets = Total Fixed Assets + Working Capital Capital Employed: Sets out how the business is financed. It is made up of Debt Capital ( Long Term Loan) & Equity Capital (Investment by shareholders). Authorsied Share Capital: The maximum amount of shares the business is allowed to issue. (Shown in Memorandum of Association.) Issued Share Capital: The amount of actual money raised by the issuing of shares.

Profitability ratios Measures profit levels and whether annual profit is improving or declining. Gross profit percentage Net profit percentage Return on capital employed

Gross Profit Margin Shows the amount of gross profit made from sales. E.G A gross margin of 30 % means that for every € of sales revenue the business is earning 30% gross profit. High

Net Profit Margin Shows the amount of net profit made from sales. E.G A net margin of 20% means that for every € of sales revenue the business is earning 20% net profit. High

Return on Capital Employed ROI shows the profit earned as a % of the money invested. High

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Liquidity ratios Used to examine cash flow and reflect a firm’s ability to pay its day-to-day expenses. Working capital ratio (current ratio) Acid test ratio (quick ratio)

Working Capital / Current Ratio Current assets need to be greater then Current Liabilities. E.G. For every €1 of debt in the business it should have €2 to cover it.

Which of the following are the easiest to turn into cash the fastest? Rank them in order. Cash in Bank Bank Deposits Debtors Stock of Goods

Acid Test Ratio Ideal result is 1:1. Stock can be difficult to convert to cash quickly.

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Gearing ratios It highlights a businesses reliance on borrowings or debt capital to finance its operations. Debt capital: equity capital

Gearing ratios If debt > equity, company is highly geared. If debt < Equity, Company is lowly geared.

Low Gearing Less risky as under less pressure to meet fixed interest loan repayments Increase dividend to shareholders Plough profits back into the business High Gearing Large amount of external debt Risky in times of slow growth of business e.g. recession – leads to liquidity problems/ poor credit ratings/ bankruptcy Difficult to source finance

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