Transcript FINANCIAL STATEMENT ANALYSIS

FINANCIAL STATEMENT ANALYSIS
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)
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
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.
TYPES OF RATIOS
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Liquidity Ratios
Profitability Ratios
Efficiency / Activity Ratios
Gearing / Solvency Ratios
Investors/ Shareholders Ratios
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
Eg. 2:1
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.
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.
EFFICIENCY / ACTIVITY RATIOS
RATIO
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.
GEARING / SOLVENCY RATIO
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%.
INVESTOR / SHAREHOLDER RATIO
RATIO
CALCULATION
MEANING
USE
Earnings Per Share
(EPS)
(Net ProfitPreference 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.
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.