1. Analysing and interpreting financial statements
OBJECTIVES
You should be able to:
Calculate important ratios for determining the financial performance and position of a business and explain the significance of the ratios calculated
Identify the major categories of ratios that can be used for analysis purposes
Discuss the limitations of ratios as a tool of financial analysis
Explain the importance of gearing to a business and its owners

2. Financial ratio classification
Categories
Profitability
Efficiency
Liquidity
Gearing
Investment

3. Return on ordinary shareholders’ funds Return on capital employed
Profitability ratios
Return on ordinary shareholders’ funds
Return on capital employed
Net profit margin
Gross profit margin
Formula
Net profit after taxation and preference dividend (if any) x Ordinary share capital + Reserves
Net profit before interest and taxation x 100 Share capital + Reserves + Long-term loans
Net profit before interest and taxation x Sales
Gross profit x Sales

4. Efficiency ratios Formula Average stock turnover period
Average settlement period for debtors
Average settlement period for creditors
Sales to capital employed
Formula
Average stock held x 365 Cost of sales
Sales per employee
Trade debtors x 365 Credit sales
Trade creditors x 365 Credit purchases
Sales Long-term capital employed
Sales Number of employees

5. The main elements comprising the ROCE ratio
Sales Long-term capital employed
Return on capital employed
multiplied by
equals
Net profit before interest and taxation sales

6. Liquidity ratios Formula Current ratio Acid test ratio
Current assets Current liabilities (creditors due within one year)
Current assets (excluding stock) Current liabilities

7. Gearing ratios Formula
Interest cover ratio
Formula
Profit before interest and taxation Interest payable
Long-term liabilities Share capital + Reserves + Long-term liabilities

8. The effect of financial gearing
Profit before
interest and tax

9. Investment ratios Formula
Dividend payout ratio
Dividend yield ratio
Earnings per share
Formula
Dividends announced for the year x 100 Earnings for the year available for dividends
Dividend per share/(1- t) x 100 Market value per share
Earnings available to ordinary shareholders Number of ordinary shares in issue
Price/earnings ratio (P/E)
Market value per share Earnings per share

10. Average dividend yield ratios for businesses in a range of Industries1 2 6 5 4 3
Oil and gas
Construction and building materials
Chemicals
Engineering and machinery
Pharmaceuticals and biotechnology
Tobacco
Food and drug retailers
Electricity
Real estate
Transport
Leisure and hotels
Banks
3.67
4.35
4.42
5.15
2.85
4.52
3.98
4.29
3.35
6.32
3.16
4.83
Source: Constructed from data appearing in the Financial Times, 18 January 2003

11. Average price/earnings ratios for businesses in a range of industries5 10 30 25 20 15
Oil and gas
Construct. and building materials
Chemicals
Engineering and machinery
Pharmaceuticals and biotechnology
Tobacco
Food and drug retailers
Electricity
Real estate
Transport
Leisure and hotels
Banks
22.86
8.45
16.77
12.87
18.62
12.54
18.83
12.93
14.06
22.63
23.18
12.67
Source: Constructed from data appearing in the Financial Times, 18 January 2003

12. Graph plotting current ratio against time
2000
2003
2002
2001
2004
XYZ Ltd
Industry average