1. FINANCIAL STATEMENT ANALYSIS

2. RATIOS ANALYSIS
A tool used by individuals to conduct a quantitative analysis of information in a company’s financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. (Source: Investopedia)

3. ADVANTAGES OF RATIO ANALYSIS
It simplifies financial statements
It helps in comparing companies of different size with each other
It helps in trend analysis which involves comparing a single company over a period
It highlights important information in a simple to use form quickly. A user can judge a company by just looking at a few numbers instead of reading the whole financial statements

4. LIMITATIONS OF RATIO ANALYSIS
One ratio result is not very helpful. Comparisons need to be made.
May be difficult to compare firms in different industries.
Trend analysis need to take into account changing circumstances over time which could have affected the ratio results.
Ratios are only concerned with accounting items to which a numerical value can be given. There are qualitative factors to consider.

5. TYPES OF RATIOS Liquidity Ratios Profitability Ratios
Efficiency / Activity Ratios
Gearing / Solvency Ratios
Investors/ Shareholders Ratios

6. LIQUIDITY RATIOS RATIO CALCULATION MEANING USE Current Ratio
Current Assets / Curent Liabilities expressed as Current Assets : Current Liabilities
Eg. 2:1
This shows the ability of the firm to pay short term obligations as they fall due.
Shareholders or investors in the firm can use this ratio to determine that if all creditors were to request their funds, would the firm be able to pay its debts and not suffer because of working capital problems. The ideal ratio is 2:1.
Quick / Acid Test Ratio
(Current Assets – Stock) / Current Liabilities expressed as Current Assets - Stock : Current Liabilities
This ratio is similar to the current ratio however, stock is excluded, as it is not as liquid as other current assets. It only becomes liquid when it is sold and this takes time.
This measures the real short term liquidity of the firm since stock is excluded. There is an optimum ratio of 1:1 that firms try to keep however, a ratio of 0.55 to 1 and over is acceptable.

7. PROFITABILITY RATIOS RATIO CALCULATION MEANING USE Gross Profit Margin
(Gross Profit / Sales Revenue) x 100 expressed as a %
Shows the % of profit that is left after subtracting COGS from Sales. This is the amount available to pay expenses.
Indicates how effectively management uses labour and supplies. Shows how much is left to spend on other operations eg R & D
Net Profit Margin
(Net Profit / Sales Revenue) x 100 expressed as a %
Reflects the performance os a business as it indicates how expenses are controlled.
To get a good sense of the non-direct costs such as administration and marketing. Assists in controlling them.
Return on Capital Employed (ROCE)
(Net Profit / Capital Employed) x 100 expressed as a %.
Capital Employed = Fixed Assets + (Current Assets – Current Liabilities)
Measures the extent to which capital is used to make a profit
Used to determine the feasibility of the current investment in the firm.

8. EFFICIENCY / ACTIVITY RATIOS
CALCULATION
MEANING
USE
Stock Turnover Ratio
Cost of Sales / Average Stock where Average Stock = (Opening Stock + Closing Stock) / 2
Shows the number of times stock is ordered or replenished by the business for the year
Can assist the firm in determining how best to hold stock. Can also indicate sales trends for planning purposes.
Debtor Days Ratio
(Debtors / Credit Sales) x 365
Shows the average length of time it takes for the firm to collect its debts
Normally combined with the creditor days ratio to indicate the cash flow situations.
Creditor Days Ratio
(Creditors / Credit Purchases) x 365
Shows average length of time to pay short term debts
Normally combined with the debtor days ratio to indicate the cash flow situations.

9. GEARING / SOLVENCY RATIO
CALCULATION
MEANING
USE
Gearing / Leverage Ratio
(Long Term Debt / Capital Employed) x 100 expressed as a %
Measures the degree to which capital of the business is financed by long term loans
Shows the risk of investing in this type of business. If a business is highly geared, there is a lot of risk involved. This should never be above 50%.

10. INVESTOR / SHAREHOLDER RATIO
CALCULATION
MEANING
USE
Earnings Per Share (EPS)
(Net Profit-Preference Share Dividends) / No. of Ordinary Shares
Indicates how much ordinary shares have contributed to making a profit
Can be used by investors to calculate return on investment.
Dividend Yield
Latest Annual Dividend Payment Per Share/Current Market Value Per Share
Shows dividends per share as a percentage of market price
Indicates returns earned on shares.

11. TIPS ON RATIO ANALYSIS
Once you have calculated your ratios, do not restate the figures seen if doing an evaluation but instead look at the differences.
Once a comparison is made, make inferences about the reason why the ratios are as they are.
Ensure that you remember basic financial statements
These are NOT ALL ratios, they are only the ones on the syllabus. A ratio is any form of comparison between figures and therefore you can be asked to calculate anything. Eg Wages to Sales Ratio.