1. Ratio Analysis – Uses and Limitations
3.5 Assessing competitiveness

2. b) Interpret ratios to make business decisions
What you need to know
b) Interpret ratios to make business decisions
c) The limitations of ratio analysis

3. Concept links Ratio Analysis Business performance Profitability
Liquidity
Efficiency
Corporate objectives

4. What is Ratio Analysis?
Ratio analysis involves the comparison of financial data to gain insights into business performance

5. Ratio Analysis Helps Answer Questions Such As…
Why is one business more profitable than another?
What returns are being earned in investment in a business?
Is a business able stay solvent?
How effectively is a business using its assets?

6. Where Does the Information for Ratio Analysis Come From?
Statement of comprehensive income
Statement of financial position
Revenues
Cost of Sales
Gross Profit
Operating Profit
Net Profit (Profit for the Year)
Current assets
Current liabilities
Inventories
Trade receivables & payables
Long-term liabilities
Capital & reserves

7. Key Stages in Ratio Analysis
Gather data
Calculate ratios
Interpret results
Take action

8. The Main Groups of Ratios
Profitability
Gross profit margin
Operating profit margin
Return on Capital Employed
Liquidity
Current ratio
Acid-test ratio
Financial Efficiency
Payables Days
Receivables Days
Inventory turnover
Gearing

9. Key Users of Ratios Shareholders Government Competitors Employees
Profitability
Liquidity
Financial Efficiency
Shareholders
Government
Competitors
Employees
Shareholders
Lenders
Suppliers
Shareholders
Lenders
Competitors

10. Be Aware of Limitations of Ratio Analysis
One data set is not enough
Reliability of data?
Based on the past
Comparability?

11. Why Might Ratio Data Not be Entirely Reliable?
Financial information involves making subjective judgements
Different businesses have different accounting policies
Potential for manipulation of accounting information (e.g. window-dressing)

12. The Importance of Effective Comparison
One ratio is rarely enough
Need to compare with competitors
Need to analyse over time (trends)
Circumstances change over time
Markets and industries change
Different economic and market conditions

13. What Ratios Don’t Tell You…
Competitive advantages: e.g. brand strength
Quality
Ethical reputation
Future prospects
Changes in the external environment