Ratio Analysis

Ratio Analysis

1. Financial Statements

   • Values published are absolute figures
   • Difficult to compare different sized businesses
   • Need to compare
     • Info from a ratio on its own is v.limited
     • Past Periods
     • Similar businesses
     • Objectives/targets

2. Types of Ratio

   • Profitability
   • Liquidity
   • Efficiency
   • Debt
   • Investors

3. Gross Profit Percentage

   • Gross Profit = Revenue-Cost of sales
   • Gross Profit/Revenue X 100
   • Relationship between revenue and direct costs
   • % of each £ left after the business has paid for its materials, labour etc
   • The higher the better
   • Important to competitiors

4. Cash

   • Comes from: investors putting in capital, receipts from sales, sales of non-current assets, banks agreeing to loans and overdrafts
   • critical balance between inflows and outflows
   • Big profit doesn't necessarily mean the business is doing well
     • e.g.overtrading
       • This is when a business invests too much in non-current assets(often during rapid expansion) and not enough is kept for day-to-day trading and emergencies. 
   • liquidity
     • Good=business has lots of cash/near cash assets compared to bills
     • working capital=current assets-current liabilities

5. Markup

   • Amount added to the cost of sales to give the selling price

6. Net profit Percentage

   • profit from operations/revenue X 100
   • Profit before finance and tax deducted
   • Represents pure profits earned on each £ of revenue after expenses

7. Return on Capital Employed(ROCE)

   • Rate at which the business is earning profit relative to the money invested-relates earnings to the level of investment in the business
   • Profit from operations/capital employed
     • Capital employed= shareholder's funds + long term liabilities
   • reflects the financial risk
   • gives shareholders a % to compare to the interest rates

8. Asset turnover

   • revenue/capital employed X 100
   • link between investment + income and ultimate profit
   • Indicates the efficiency of the business' use of its assets to generate revenue.
   • great interest to management
   • Higher the better but too high >overtrading

9. Earnings per share(EPS)

   • profit after tax/number of ordinary shares
     • profit after tax=all costs deducted
   • fundamental measure of share performance
   • Assesses potential-relates available profit for distribution to number of shares
     • trends created
   • less shares=more per share
   • Business may buy bad shares-lots of shares issued-profits diluted

10. Limitations

    • must combine with other areas
    • accuracy depends on reliability of data
    • Differing accountig policies
    • Ratios tell us what has happened but not why
    • Don't analyse aspects without numbers attached e.g. morale/goodwill