1. Ratio Analysis

2. Use of Ratio Analysis To analyse Performance Liquidity Shareholder Investment

3. Performance Ratios ROCE Gross profit margin Net profit margin

4. ROCE Return On Capital Employed - relates a firms profitability in relation to the investors capital investment ROCE = profit before tax + finance costs + pref. dividends x 100% (Total Assets-Current Liabilities)

5. Gross Profit Margin The ‘mark-up’. This shows the gross profit made on sales turnover. Gross profit margin = gross profit x 100% Sales revenues A large range of profit may affect the true results Useful when comparing against the margins of previous years.

6. Net Profit Margin This shows how well a business controls its overheads Net profit margin = Net profit x 100% Sales Revenue

7. Liquidity Ratios Measure a firm’s ability to meet short- term obligations, collect receivables, and maintain a cash position How well is the organisation able to meet its short-term obligations? Current ratioAcid test ratio

8. Current Ratio Measures a company's ability to pay short-term obligations. Current ratio = current assets/current liabilities Current ratio = x:1 Suggested Rule of thumb 2:1

9. Acid Test Ratio/ Quick Ratio Determines risk undetected by the Working Capital ratio Acid test ratio = (Current Assets–Closing Inventory) Current Liabilities Acid test ratio = x:1 An extreme version of the working capital ratio because it only uses cash and equivalents. The ratio excludes inventory, which for some companies can make up a large portion of its assets. Suggested Rule of thumb 1:1

10. Gearing Ratio Compares owner's equity (or capital) to borrowed funds. Shows how risky a company is financially Gearing ratio = Non-current Liabilities (Debt) x 100% = x% (Equity Capital + Reserves + Debt Capital)

11. Shareholders Ratios Earning per share Return on equity

12. Earning per Share (EPS) This measure expresses how many pence the company is earning for every share held. Earnings per Share = Profit for the year No. of ordinary shares in issue =x pence

13. Return on Equity A measure of how well a company used reinvested earnings to generate additional earnings ROE = (Net profit for the year – preference dividend) x 100% Ordinary Share Capital + Reserves

14. Advantages of Ratio Analysis Can assist in interpreting and evaluating income statements and balance sheets by reducing the amount of data contained in them to a workable amount Can make financial data more meaningful Help to determine relative magnitudes of financial quantities Help managers or business analysts make effective decisions about the firm's credit worthiness Can assist with predicting potential business earnings Can assist in seeing financial business strengths Can assist in spotting business weaknesses

15. Disadvantages of Ratio Analysis Comparing the ratios with past trends and with competitors may not give a correct picture as the figures may not be easily comparable due to the difference in accounting policies, accounting period etc. It gives current and past trends, but not future trends. Impact of inflation is not properly reflected, as many figures are taken at historical numbers, several years old. There are differences in approach among financial analysts on how to treat certain items, how to interpret ratios etc. The ratios are only as good or bad as the underlying information used to calculate them.

16. Factors Affecting Ratio Analysis Inflation External factors eg pollution Management changes Yearly comparisons Performance State of the economy Performance of competitors

17. Difference between cash and profit Cash is considered cash and cheques It’s a liquid asset of the business Cash is the inflow of money into the business bank account (actual money received, rather than what is ‘promised’) Cash also flows out of the business – e.g. paying suppliers bills. Not all bills are paid by cash – many are on credit terms

18. Profit This is measured by taking the costs away from the sales revenue It’s different from cash because profit is the money earned by the business, and is represented on paper (in the accounts) Because sales can be made on credit terms, not just cash, then it’s different to cash flow