Ratio analysis

Ratio analysis

1. Gearing %

   • Non current liabilities/ capital employed ( equity + NCL) x 100
     • measures proportion of capital used in the business which is debt with interest
     • ideally 50% otherwise considered high/low
       • LOW- shows they are risk averse
         • may miss out on growth opportunities in dynamic markets
           • long term may lead to lower profits and dividends
         • less difficulty repaying
     • HIGH- if 50% or above, firm at risk if industry declines as have to keep paying even if cash flow diminishing
       • however, if economy is growing, repayment is easy
         • less risky
       • can show that firm is willing to expand
         • thus leads to higher profits and dividends

2. Roce %

   • operating profit/ capital employed x100
     • tells managers how much money is being made compared to how much Is being put in to the firm
       • how much each pound has generated in profit
     • higher the better
       • needs to be compared with previous years
     • make good profit if roce is higher than interest rate on loans
   • decline in roce means the firm needs to be more efficient & make more profit

3. Gross/operating/net profit margins

   • (Gross/op/net profit/revenue) x100
     • the higher the better
     • needs to be compared to see improvements or declines
     • low g/o/npm= need to lower costs

4. Current ratio

   • current assets/ current liabilities
     • sufficient liquid resources if between 1.5 and 2
       • below indicated the firm doesn't have enough working capital
         • over borrowing?
         • retailers often have it below as they get most of cash from sales
       • above may mean too much money is tied up unproductively

5. Acid test ratio

   • (current assets- inventories) / current liabilities
     • stocks are not counted as there is no guarantee they will be sold
     • ideal ratio is 1:1
       • less than one could mean it doesn't have enough current assets - stock to cover its current liabilities