1. © Pearson Education 2002 Financial ratio classification Categories Profitability Efficiency Liquidity Gearing Investment

2. © Pearson Education 2002 Select and calculate appropriate ratios Identify users and their information needs Interpret and evaluate the results The key steps of financial ratio analysis

3. © Pearson Education 2002 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 100 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 100 Sales Gross profit x 100 Sales Sales

4. © Pearson Education 2002 Efficiency ratios 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_______ Number of employees _______ Sales__________ Long-term capital employed

5. © Pearson Education 2002 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. © Pearson Education 2002 Liquidity ratios Current ratio Acid test ratio Operating cash flows to maturing obligations Formula Current assets_______________ Current liabilities (creditors due within one year) Operating cash flows Current liabilities Current assets (excluding stock) Current liabilities

7. © Pearson Education 2002 Average current ratio and average acid test ratio for UK listed companies in various industrial sectors Source: Datastream data, February 2001 Current ratio Acid test ratio Chemicals 0.0 Electricity Food and drugs retailers Food producers 0.2 0.4 0.6 0.8 1.0 1.6 1.2 1.4 Household goods and textiles 2.0 1.8 Information Technology Hardware Water

8. © Pearson Education 2002 Gearing ratios Gearing ratio Interest cover ratio Formula Profit before interest and taxation_ Interest payable Long-term liabilities _______ Share capital + Reserves + Long-term liabilities

9. © Pearson Education 2002 The effect of financial gearing

10. © Pearson Education 2002 Investment ratios Dividend per share Dividend payout ratio Dividend yield ratio Earnings per share Formula Dividends announced during the period Number of shares in issue Operating cash flow per share 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 Price/earnings ratio (P/E) Earnings available to ordinary shareholders Number of ordinary shares in issue Operating cash flows – preference dividends Number of ordinary shares in issue Market value per share Earnings per share

11. © Pearson Education 2002 Average dividend yield ratios 0 1 2 6 5 4 3 Oil and gas Construction and building materials Chemicals Engineering and machinery Pharma- ceuticals Tobacco Food and drug retailers Electricity Water Distribution Restaurants and pubs Banks 2.53 3.79 3.77 5.82 1.54 5.35 2.85 1.95 2.22 4.19 6.62 2.84 Source: Constructed from information in Financial Times, 8 December 2000

12. © Pearson Education 2002 Average P/E ratios Oil and gas Construction and building materials Chemicals Engineering and machinery Pharmaceuticals Tobacco Food and drug retailers Electricity Water Distribution Restaurants and pubs Banks 0 25 30 35 20 15 10 5 40 13.91 10.21 13.38 8.53 11.60 17.93 26.84 22.51 12.11 9.89 16.83 41.50 Source: Constructed from information in Financial Times, 8 December 2000

13. © Pearson Education 2002 Current ratio Time 19972000 19991998 2001 XYZ Ltd Industry average Graph plotting current ratio against time

14. © Pearson Education 2002 Mean ratios of failed and non-failed businesses

15. © Pearson Education 2002 Mean ratios of failed and non-failed businesses

16. © Pearson Education 2002 Scatter diagram showing the distribution of failed and non-failed businesses Current ratio ROCE ratio Non-failed businesses Failed businesses